Corporate Finance
Final Test Solutions
Course Introduction
Corporate Finance explores the fundamental principles and practices that govern financial decision-making within corporations. The course covers essential topics such as capital budgeting, valuation of assets and firms, risk and return analysis, capital structure, dividend policy, and the cost of capital. Students will examine the ways in which financial managers use analytical tools to make investment, financing, and payout decisions that maximize shareholder value. Through case studies, problem-solving exercises, and theoretical frameworks, participants develop a strong understanding of how financial markets function, how companies raise and allocate resources, and how financial strategies support long-term corporate growth.
Recommended Textbook Fundamentals of Corporate Finance 9th Asia Global Edition by Stephen A. Ross
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Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) A stakeholder is:
A)a person who owns shares of stock.
B)any person who has voting rights based on stock ownership of a corporation.
C)a person who initially founded a firm and currently has management control over that firm.
D)a creditor to whom a firm currently owes money.
E)any person or entity other than a stockholder or creditor who potentially has a claim on the cash flows of a firm.
Answer: E
Q2) Give some examples of ways in which manager's goals can differ from those of shareholders.
Answer: The primary goal of a financial manager should be to maximize the current value of the outstanding stock. This goal focuses on enhancing the returns to stockholders who are the owners of the firm. However, managers frequently are more concerned with their personal benefits from employment, the prestige of their position, and the perks to which they feel entitled. There are numerous examples, some of which are excessive compensation packages, large corporate offices, excessive staffing, and first-class travel and conference locations, to name a few.
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Chapter 2: Financial Statements, Taxes, and Cash Flow
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Q1) Jake owns The Corner Market which he is trying to sell so that he can retire and travel. The Corner Market owns the building in which it is located. This building was built at a cost of $647,000 and is currently appraised at $819,000. The counters and fixtures originally cost $148,000 and are currently valued at $65,000. The inventory is valued on the balance sheet at $319,000 and has a retail market value equal to 1.2 times its cost. Jake expects the store to collect 98 percent of the $21,700 in accounts receivable. The firm has $26,800 in cash and has total debt of $414,700. What is the market value of this firm?
A)$857,634
B)$900,166
C)$919,000
D)$1,314,866
E)$1,333,700
Answer: B
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Chapter 3: Working With Financial Statements
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Sample Questions
Q1) What is the return on equity for 2012? (Use 2012 values)
A)15.29 percent
B)16.46 percent
C)17.38 percent
D)18.02 percent
E)18.12 percent
Answer: D
Q2) Which one of the following statements is correct?
A)Book values should always be given precedence over market values.
B)Financial statements are frequently used as the basis for performance evaluations.
C)Historical information provides no value to someone who is predicting future performance.
D)Potential lenders place little value on financial statement information.
E)Reviewing financial information over time has very limited value.
Answer: B
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Page 5
Chapter 4: Long-Term Financial Planning and Growth
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Sample Questions
Q1) Assume that Major Manuscripts, Inc. is currently operating at 95 percent of capacity and that sales are projected to increase to $20,000. What is the projected addition to fixed assets?
A)$0
B)$1,493
C)$1,529
D)$1,546
E)$1,588
Q2) Hungry Howie's maintains a constant payout ratio. The firm is currently operating at full capacity. What is the maximum rate at which the firm can grow without acquiring any additional external financing?
A)9.74 percent
B)10.52 percent
C)11.06 percent
D)11.58 percent
E)12.23 percent
Q3) Smith & Daughters is getting ready to compile pro forma statements for the next few years. How can the managers establish a reasonable range of growth rates that they should consider during this planning process?
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Chapter 5: Introduction to Valuation: The Time Value of Money
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Sample Questions
Q1) Terry is calculating the present value of a bonus he will receive next year. The process he is using is called:
A)growth analysis.
B)discounting.
C)accumulating.
D)compounding.
E)reducing.
Q2) When you retire 40 years from now, you want to have $1.2 million. You think you can earn an average of 12 percent on your investments. To meet your goal, you are trying to decide whether to deposit a lump sum today, or to wait and deposit a lump sum 2 years from today. How much more will you have to deposit as a lump sum if you wait for 2 years before making the deposit?
A)$1,414.14
B)$2,319.47
C)$2,891.11
D)$3,280.78
E)$3,406.78
Q3) What lesson does the future value formula provide for young workers who are looking ahead to retiring some day?
Page 7
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Chapter 6: Discounted Cash Flow Valuation
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Sample Questions
Q1) Which of the following statements related to interest rates are correct?
I. Annual interest rates consider the effect of interest earned on reinvested interest payments.
II. When comparing loans, you should compare the effective annual rates.
III. Lenders are required by law to disclose the effective annual rate of a loan to prospective borrowers.
IV. Annual and effective interest rates are equal when interest is compounded annually.
A)I and II only
B)II and III only
C)II and IV only
D)I, II, and III only
E)II, III, and IV only
Q2) Why might a borrower select an interest-only loan instead of an amortized loan, which would be cheaper?
Q3) Explain the difference between the effective annual rate (EAR) and the annual percentage rate (APR). Of the two, which one has the greater importance and why?
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8
Chapter 7: Interest Rates and Bond Valuation
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Q1) All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.
A)a premium; less than B)a premium; equal to C)a discount; less than D)a discount; higher than E)par; less than
Q2) A bond that can be paid off early at the issuer's discretion is referred to as being which one of the following?
A)zero coupon
B)callable
C)senior
D)collateralized
E)unsecured
Q3) An indenture is:
A)another name for a bond's coupon.
B)the written record of all the holders of a bond issue.
C)a bond that is past its maturity date but has yet to be repaid.
D)a bond that is secured by the inventory held by the bond's issuer.
E)the legal agreement between the bond issuer and the bondholders.
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Chapter 8: Stock Valuation
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Sample Questions
Q1) Dexter Metals, paid its first annual dividend yesterday in the amount of $0.18 a share. The company plans to double each annual dividend payment for the next 3 years. After that time, it plans to pay $1.25 a share for 2 years than then pay a constant dividend of $1.60 per share indefinitely. What is one share of this stock worth today if the market rate of return on similar securities is 10.24 percent?
A)$12.32
B)$12.77
C)$13.20
D)$14.26
E)$14.79
Q2) The preferred stock of Rail Lines, Inc., pays an annual dividend of $7.50 and sells for $59.70 a share. What is the rate of return on this security?
A)10.38 percent
B)11.63 percent
C)12.56 percent
D)12.72 percent
E)12.84 percent
Q3) Explain why small shareholders should prefer cumulative voting over straight voting. To view all questions and flashcards with answers, click on the resource link above. Page 10
Chapter 9: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) Mutually exclusive projects are best defined as competing projects which:
A)would commence on the same day.
B)have the same initial start-up costs.
C)both require the total use of the same limited resource.
D)both have negative cash outflows at time zero.
E)have the same life span.
Q2) A project has a required payback period of three years. Which one of the following statements is correct concerning the payback analysis of this project?
A)The cash flows in each of the three years must exceed one-third of the project's initial cost if the project is to be accepted.
B)The cash flow in year three is ignored.
C)The project's cash flow in year three is discounted by a factor of (1 + R)<sup>3</sup>.
D)The cash flow in year two is valued just as highly as the cash flow in year one. E)The project is acceptable whenever the payback period exceeds three years.
Q3) The profitability index (PI) of a project is 1.0. What do you know about the project's net present value (NPV) and its internal rate of return (IRR)?
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Chapter 10: Making Capital Investment Decisions
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Sample Questions
Q1) The Card Shoppe needs to maintain 23 percent of its sales in net working capital. Currently, the shoppe is considering a 6-year project that will increase sales from its current level of $387,000 to $421,000 the first year and to $465,000 a year for the following 5 years of the project. What amount should be included in the project analysis for net working capital in year 6 of the project?
A)-$17,940
B)-$2,990
C)$0
D)$2,990
E)$17,940
Q2) The bid price is:
A)an aftertax price.
B)the aftertax contribution margin.
C)the highest price you should charge if you want the project.
D)the only price you can bid if the project is to be profitable.
E)the minimum price you should charge if you want to financially breakeven.
Q3) What is the formula for the tax-shield approach to OCF?
Explain the two key points the formula illustrates.
Q4) Can the initial cash flow at time zero for a project ever be a positive value? If yes, give an example. If no, explain why not.
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Chapter 11: Project Analysis and Evaluation
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Sample Questions
Q1) Fixed costs:
A)change as a small quantity of output produced changes.
B)are constant over the short-run regardless of the quantity of output produced.
C)are defined as the change in total costs when one more unit of output is produced.
D)are subtracted from sales to compute the contribution margin.
E)can be ignored in scenario analysis since they are constant over the life of a project.
Q2) A project has an accounting break-even point of 15,329 units. The fixed costs are $382,000 and the projected variable cost per unit is $29.10. The project will require $780,000 for fixed assets which will be depreciated straight-line to zero over the project's 6-year life. What is the projected sales price per unit?
A)$47.65
B)$48.18
C)$54.02
D)$56.67
E)$62.50
Q3) What is operating leverage and why is it important in the analysis of capital expenditure projects?
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Page 13
Chapter 12: Some Lessons From Capital Market History
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Sample Questions
Q1) What was the average rate of inflation over the period of 1926-2007?
A)less than 2.0 percent
B)between 2.0 and 2.5 percent
C)between 2.5 and 3.0 percent
D)between 3.0 and 3.5 percent
E)greater than 3.5 percent
Q2) Which one of the following time periods is associated with high rates of inflation?
A)1929-1933
B)1957-1961
C)1978-1981
D)1992-1996
E)2001-2005
Q3) You own 400 shares of Western Feed Mills stock valued at $51.20 per share. What is the dividend yield if your annual dividend income is $352?
A)1.68 percent
B)1.72 percent
C)1.83 percent
D)1.13 percent
E)1.21 percent
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Page 14
Chapter 13: Return, Risk, and the Security Market Line
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Sample Questions
Q1) Which one of the following statements is correct concerning a portfolio beta?
A)Portfolio betas range between -1.0 and +1.0.
B)A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.
C)A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification.
D)A portfolio of U.S.Treasury bills will have a beta of +1.0.
E)The beta of a market portfolio is equal to zero.
Q2) Standard deviation measures which type of risk?
A)total
B)nondiversifiable
C)unsystematic
D)systematic
E)economic
Q3) Explain the difference between systematic and unsystematic risk. Also explain why one of these types of risks is rewarded with a risk premium while the other type is not.
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15
Chapter 14: Cost of Capital
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Sample Questions
Q1) Which one of the following is the primary determinant of a firm's cost of capital?
A)debt-equity ratio
B)applicable tax rate
C)cost of equity
D)cost of debt
E)use of the funds
Q2) Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1,000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quoted at 87 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent?
A)4.10 percent
B)4.42 percent
C)6.61 percent
D)8.90 percent
E)10.67 percent
Q3) Explain how the use of internal equity rather than external equity affects the analysis of a project.
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16
Chapter 15: Raising Capital
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Q1) Which one of the following statements is correct concerning the costs of issuing securities?
A)Domestic bonds are generally more expensive to issue than equity IPOs.
B)Abnormal returns are rarely associated with seasoned issues.
C)A seasoned offering is typically more expensive on a percentage basis than an IPO.
D)There tends to be substantial economies of scale when issuing securities.
E)The costs of issuing convertible bonds tend to be less on a percentage basis than the costs of issuing straight debt.
Q2) Underwriters generally:
A)pay a spread to the issuing firm.
B)provide only best efforts underwriting in the U.S.
C)receive less compensation under a competitive agreement than under a negotiated agreement.
D)market and distribute an entire issue of new securities within their own firm.
E)pass the risk of unsold shares back to the issuing firm via a firm commitment agreement.
Q3) Firms encounter several costs when issuing new securities. Identify and describe at least four of these costs.
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Chapter 16: Financial Leverage and Capital Structure Policy
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Q1) The interest tax shield is a key reason why:
A)the required rate of return on assets rises when debt is added to the capital structure.
B)the value of an unlevered firm is equal to the value of a levered firm.
C)the net cost of debt to a firm is generally less than the cost of equity.
D)the cost of debt is equal to the cost of equity for a levered firm.
E)firms prefer equity financing over debt financing.
Q2) Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.
A)At the break-even point, there is no advantage to debt.
B)The earnings per share will equal zero when EBIT is zero for a levered firm.
C)The advantages of leverage are inversely related to the level of EBIT.
D)The use of leverage at any level of EBIT increases the EPS.
E)EPS are more sensitive to changes in EBIT when a firm is unlevered.
Q3) Based on the M&M propositions with and without taxes, how much time should a financial manager spend analyzing the capital structure of a firm?
What if the analysis is based on the static theory?
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18
Chapter 17: Dividends and Dividend Policy
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Q1) Which one of the following statements related to dividend policy is correct?
A)The primary question related to dividend policy is whether or not a firm should ever pay a dividend.
B)Both dividends and dividend policy are irrelevant.
C)Dividend policy focuses on the timing of dividend payments.
D)Homemade dividends increase the importance of a firm's dividend policy decisions.
E)Whether or not a firm ever pays a dividend is irrelevant to equity valuation.
Q2) South Shore Limited has 21,000 shares of stock outstanding with a par value of $1 per share and a market price of $7.50 a share. The firm just announced a 5-for-2 stock split. What will the par value of the stock be after the split?
A)$0.40
B)$0.80
C)$1.00
D)$1.40
E)$1.60
Q3) Explain the meaning of the dividend clientele effect and why it is important.
Q4) Identify some real-world factors which might make it more difficult for an individual to effectively create a homemade dividend policy.
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Page 19
Chapter 18: Short-Term Finance and Planning
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Sample Questions
Q1) Kid's Delight expects to sell $8,200 worth of toys in December, $3,700 worth in January, $4,400 in February, and $6,100 in March. The wholesale cost is 72 percent of the retail price. The firm has a receivables period of 30 days, a payables period of 60 days, and buys inventory one month prior to selling it. Which one of the following statements is correct?
A)The February payments to suppliers are $2,992.
B)The March collections are $3,700.
C)The accounts receivable balance at the end of March is $4,400.
D)The purchases for February are $3,168.
E)The accounts payable balance at the end of January is $5,832.
Q2) Peterson's Antiquities currently has a 31 day cash cycle. Assume the firm changes its operations such that it decreases its receivables period by 2 days, decreases its inventory period by 3 days, and decreases its payables period by 4 days. What will the length of the cash cycle be after these changes?
A)22 days
B)23 days
C)29 days
D)30 days
E)31 days
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Page 20
Chapter 19: Cash and Liquidity Management
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Q1) Your firm spends $48,000 a week to pay bills and maintains a lower cash balance limit of $50,000. The standard deviation of the disbursements is $8,600. The applicable weekly interest rate is 0.054 percent and the fixed cost of transferring funds is $65. What is your cash balance target based on the Miller-Orr model?
A)$48,156
B)$49,990
C)$54,884
D)$68,830
E)$75,726
Q2) Explain how the Check Clearing Act for the 21<sup>st</sup> Century affects both collection and disbursement float.
Q3) The main purpose of a cash concentration account is to:
A)decrease collection float.
B)decrease disbursement float.
C)consolidate funds.
D)replace a lockbox system.
E)cover compensating balance requirements.
Q4) Explain how a lockbox system operates and why a firm might consider implementing such a system.
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Chapter 20: Credit and Inventory Management
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Q1) A firm offers terms of 2/9, net 41. What effective annual interest rate does the firm earn when a customer does not take the discount?
A)18.67 percent
B)20.45 percent
C)23.37 percent
D)25.34 percent
E)25.92 percent
Q2) Why might firms forego discounts offered by their suppliers even though it is costly to do so?
What steps might a firm pursue to be able to take these discounts?
Q3) One of the best selling items L.T. Ten offers sells for $9.99 a unit. The variable cost per unit is $6.38 and the carrying cost per unit is $1.12. The firm sells 7,100 of these units each year. The fixed cost to order this item is $75. What is the economic order quantity?
A)690 units
B)747 units
C)975 units
D)1,157 units
E)1,260 units
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Chapter 21: International Corporate Finance
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Q1) Which one of the following is a suggested method of reducing a U.S. importer's short-run exposure to exchange rate risk?
A)entering a forward exchange agreement timed to match the invoice date
B)investing U.S.dollars when an order is placed and using the investment proceeds to pay the invoice
C)exchanging funds on the spot market at the time an order is placed with a foreign supplier
D)exchanging funds on the spot market at the time an order is received
E)exchanging funds on the spot market at the time an invoice is payable
Q2) You would like to purchase a security that is issued by the British government. Which one of the following should you purchase?
A)Samurai bond
B)kronor
C)Euro
D)LIBOR
E)gilt
Q3) Using currencies A, B, and C construct an example in which triangle arbitrage exists and then show how to exploit it.
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Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) A general rule used as the basis for decision making is referred to as:
A)a loss aversion technique.
B)heuristics.
C)self-attribution.
D)narrow framing
E)confirmation bias
Q2) Which of the following create limits to arbitrage?
I. risks related to an individual firm
II. implementation costs
III. rational traders
IV. noise traders
A)I and III only
B)II and IV only
C)I, II, and III only
D)I, II, and IV only
E)I, II, III, and IV
Q3) Explain why a low-priced, low trading volume stock is more apt to present limits to arbitrage than is a high-priced, high trading volume stock.
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Chapter 23: Risk Management: An Introduction to Financial Engineering
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Q1) A bakery generally enters into a forward contract in wheat as a:
A)hedger.
B)speculator.
C)spot trader.
D)broker.
E)spectator.
Q2) A call option contract:
A)obligates both the buyer and the seller.
B)obligates the buyer but not the seller.
C)grants rights to the buyer and obligates the seller.
D)grants rights to the seller and obligates the buyer.
E)grants rights to both the buyer and the seller but does not obligate either party.
Q3) Which one of the following can a firm do if it effectively manages its financial risks?
A)eliminate all the risks faced by the firm
B)totally eliminate all financial risks
C)reduce the price volatility it faces
D)guarantee the firm's financial success
E)avoid all long-term financial risks
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Chapter 24: Options and Corporate Finance
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Q1) You sold three $35 call option contracts at a quoted price of $1.40. What is your net profit or loss on this investment if the price of the underlying asset is $36.70 on the option expiration date?
A)-$510
B)-$90
C)$90
D)$510
E)$930
Q2) This morning, you purchased a call option on Schoolhouse Supply Co. stock that expires in one year. The exercise price is $40. The current price of the stock is $43.40 and the risk-free rate of return is 3.6 percent. Assume the option will finish in the money. What is the current value of the call option?
A)$0
B)$1.49
C)$3.97
D)$4.79
E)$5.46
Q3) What are the basic similarities and basic differences between warrants and call options?
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26
Chapter 25: Option Valuation
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Q1) Today, you purchased 100 shares of Lazy Z stock at a market price of $47 per share. You also bought a one year, $45 put option on Lazy Z stock at a cost of $0.15 per share. What is the maximum total amount you can lose on these purchases?
A)-$4,715
B)-$4,685
C)-$4,015
D)-$215
E)-$0
Q2) A stock is currently priced at $45. A call option with an expiration of one year has an exercise price of $60. The risk-free rate is 14 percent per year, compounded continuously, and the standard deviation of the stock's return is infinitely large. What is the price of the call option?
A)$39.47
B)$42.08
C)$45.00
D)$52.63
E)$60.00
Q3) Give an example of a protective put and explain how this strategy reduces investor risk.
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Page 27
Chapter 26: Mergers and Acquisitions
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Q1) Which of the following are reasons why a firm may want to divest itself of some of its assets?
I. to raise cash
II. to unload unprofitable operations
III. to improve the strategic fit of a firm's various divisions
IV. to comply with antitrust regulations
A)I and II only
B)I, II, and III only
C)I, III, and IV only
D)II, III, and IV only
E)I, II, III, and IV
Q2) If a firm sells its crown jewels when threatened with a takeover attempt, the firm is employing a strategy commonly referred to as a _____ strategy.
A)scorched earth
B)shark repellent
C)bear hug
D)white knight
E)lockup
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Page 28
Chapter 27: Leasing
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Sample Questions
Q1) Which one of the following statements is correct concerning the lease versus buy decision?
A)The lessor is primarily concerned with returning the asset at the end of the lease term without incurring any additional charges.
B)The lessor is primarily concerned about the use of the asset.
C)If Dell Computer became a lessor of its own computers it would be engaging in direct leasing.
D)A firm should always purchase, rather than lease, any asset that has a projected positive salvage value at the end of the relevant period of use.
E)Lessors provide a source of financing for lessees.
Q2) The most cited reason why firms enter into lease agreements is to:
A)lower taxes.
B)improve cash flows.
C)reduce uncertainty.
D)avoid balance sheet reporting.
E)bypass restrictive loan covenants.
Q3) Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".
Q4) Why might a firm opt to sell and leaseback an asset which it currently owns?
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