Corporate Financial Strategy
Final Test Solutions
Course Introduction
Corporate Financial Strategy explores how organizations develop and implement financial policies and actions to achieve long-term strategic goals. The course examines key topics such as capital structure decisions, dividend policy, financing alternatives, valuation, risk management, and mergers and acquisitions. Emphasis is placed on aligning financial strategies with overall corporate objectives, optimizing value creation for shareholders, and navigating the dynamic financial environment. Through case studies and analytical tools, students gain practical insights into the decision-making processes that drive sustainable corporate growth and competitive advantage.
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 the value of trades in U.S.dollars?
A) The 10th position
B) The 8th position
C) The 20th position
D) None of the above
Answer: A
Q2) Which of the following statements is correct?
A) The TSX is an electronic exchange and investors can post orders onto the TSX trading system from anywhere in the world.
B) The TSX is an electronic exchange and investors can post orders onto the TSX trading system from anywhere in North America.
C) The TSX is an electronic exchange and investors can post orders onto the TSX trading system from anywhere in Canada.
D) The TSX is an electronic exchange and investors can post orders onto the TSX trading system from anywhere in Toronto.
Answer: A
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) The change in Luther's quick ratio from 2005 to 2006 is closest to:
A) a decrease of .10
B) an increase of .10
C) a decrease of .15
D) an increase of .15
Answer: B
Q2) Luther's price - earnings ratio (P/E)for the year ending December 31,2006 is closest to:
A) 7.9
B) 10.1
C) 15.4
D) 16.0
Answer: C
Q3) Assuming that Luther has no convertible bonds outstanding,then for the year ending December 31,2006 Luther's diluted earnings per share are closest to:
A) $1.01
B) $1.04
C) $1.53
D) $3.92
Answer: A
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Chapter 3: Arbitrage and Financial Decision Making
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Q1) If the risk-free rate of interest (r<sub>f</sub>)is 6%,then you should be indifferent between receiving $250 in one year or
A) $235.85 today.
B) $250.00 today.
C) $265.00 today.
D) none of the above
Answer: A
Q2) Which of the following statements regarding arbitrage is not correct?
A) Any situation in which it is possible to make a profit without taking any risk is known as an arbitrage opportunity.
B) Any situation in which it is possible to make a profit without making any investment is known as an arbitrage opportunity.
C) We call a competitive market in which there are no arbitrage opportunities an arbitrage market.
D) The practice of buying and selling equivalent goods in different markets to take advantage of a price difference is known as arbitrage.
Answer: C
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Chapter 4: The Time Value of Money
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Q1) If the interest rate is 6%,then the NPV of investment "A" is closest to:
A) $70
B) $43
C) -$32
D) $9
Q2) You are saving for retirement.To live comfortably,you decide that you will need $2.5 million dollars by the time you are 65.Today is your 30th birthday,and you decide that,starting today,on every birthday up to and including your 65th birthday you will deposit the same amount into your savings account.Assuming the interest rate is 5%,the amount that you must set aside each and every year on your birthday is closest to:
A) $71,430
B) $27,680
C) $26,100
D) $26,260
Q3) When you compare or combine cash flows,you can only compare or combine them
A) at different present time points.
B) at one time point.
C) at different future time points.
D) none of the above.
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Page 6
Chapter 5: Interest Rates
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Q1) Assuming you don't pay the points and borrow from the mortgage lender at 6.25%,then your monthly mortgage payment (with payments made at the end of the month)will be closest to:
A) $1,570
B) $1,530
C) $1,540
D) $1,500
Q2) In Canada,the reason an APR cannot be used as a discount rate in a mortgage calculation is
A) because it has a different compounding frequency in a year than the payment frequency in a year.
B) because it has the same compounding frequency in a year as the payment frequency in a year.
C) because it has twice the compounding frequency in a year that the payment frequency in a year has.
D) none of the above
Q3) What is the NPV of an investment that costs $2,500 and pays $1,000 certain at the end of one,three,and five years ?
Q4) Should you purchase the delivery truck or lease it? Why?
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Chapter 6: Valuing Bonds
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Q1) Consider a corporate bond with a $1,000 face value,8% coupon with semiannual coupon payments,7 years until maturity,and a YTM of 9%.It has been 57 days since the last coupon payment was made and there are 182 days in the current coupon period.The dirty (cash)price for this bond is closest to:
A) $949.70
B) $961.40
C) $936.40
D) $948.90
Q2) Which of the following statements is false?
A) The bond's expected return, which is equal to the firm's debt cost of capital, is less than the yield to maturity if there is a risk of default.
B) The two best-known bond-rating companies are Standard & Poor's and Dow Jones.
C) Bonds in the bottom five categories are often called speculative bonds, junk bonds, or high-yield bonds.
D) Bond ratings encourage widespread investor participation and relatively liquid markets.
Q3) Compute the yield to maturity for each of the five zero-coupon bonds.
Q4) Plot the zero-coupon yield curve (for the first five years).
Q5) What is the relationship between a bond's price and its yield to maturity?
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Chapter 7: Valuing Stocks
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Q1) You expect that Bean Enterprises will have earnings per share of $2 for the coming year.Bean plans to retain all of its earnings for the next three years.For the subsequent two years,the firm plans on retaining 50% of its earnings.It will then retain only 25% of its earnings from that point forward.Retained earnings will be invested in projects with an expected return of 20% per year.If Bean's equity cost of capital is 12%,then the price of a share of Bean's stock is closest to:
A) $17.00
B) $10.75
C) $27.75
D) $43.50
Q2) Which of the following statements is false?
A) There are two potential sources of cash flows from owning a stock.
B) An investor will be willing to pay a price today for a share of stock up to the point that this transaction has a zero NPV.
C) An investor might generate cash by choosing to sell the shares at some future date.
D) Because the cash flows from stock are known with certainty, we can discount them using the risk-free interest rate.
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Page 9
Chapter 8: Investment Decision Rules
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Q1) 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.
Q2) The NPV of Larry's three-movie Larry Boy offer is closest to:
A) 3.5 million
B) -1.6 million
C) 1.6 million
D) -1.0 million
Q3) Which of the following statements is false?
A) The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the NPV.
B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital.
C) For most investment opportunities expenses occur initially and cash is received later.
D) Fifty percent of firms surveyed reported using the payback rule for making decisions.
Q4) If the discount rate for project B is 15%,then what is the NPV for project B?
Q5) If the discount rate for project A is 16%,then what is the NPV for project A?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is false?
A) The simplest method used to calculate depreciation is the straight-line method.
B) A sunk cost is any unrecoverable cost for which the firm is already liable.
C) Unlevered Net Income = EBIT × <sub>c</sub>.
D) The decision to continue or abandon a project should be based only on the incremental costs and benefits of the project going forward.
Q2) The amount of incremental income taxes that the Sisyphean Company will pay in the first year on this new project is closest to:
A) $6,300
B) $5,200
C) $3,500
D) $2,800
Q3) What is a sunk cost? Should it be included in the incremental cash flows for a project? Why or why not?
Q4) What is an opportunity cost? Should it be included in the incremental cash flows for a project? Why or why not?
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) Using the data provided in the table,calculate the average annual return,the variance of the annual returns,and the standard deviation of the average returns for Microsoft from 1996 to 2005.
Q2) Which of the following types of risk doesn't belong?
A) Idiosyncratic risk
B) Undiversifiable risk
C) Market risk
D) Systematic risk
Q3) Suppose that you want to use the 10 year historical average return on the S&P 500 to forecast the expected future return on the S&P 500.The 95% confidence interval for your estimate of the expect return is closest to:
A) -10.6% to 28.2%
B) 6.8% to 10.7%
C) -37.0% to 47.6%
D) -3.5% to 21.1%
Q4) Assume that you purchased General Motors stock at the closing price on December 31,2004 and sold it at the closing price on December 30,2005.Calculate your realized annual return is for the year 2005.
Q5) What is the market portfolio?
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Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing Model
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Q1) The variance on a portfolio that is made up of equal investments in Duke Energy and Microsoft stock is closest to:
A) 0.065
B) 0.090
C) 0.149
D) -0.020
Q2) Which of the following statements is false?
A) A short sale is a transaction in which you buy a stock that you do not own and then agree to sell that stock back in the future.
B) The efficient portfolios are those portfolios offering the lowest possible level of volatility for a given level of expected return.
C) A positive investment in a security can be referred to as a long position in the security.
D) It is possible to invest a negative amount in a stock or security which is called a short position.
Q3) What are three main assumptions underlie the CAPM?
Q4) What is the variance on a portfolio that has $3,000 invested in Duke Energy,$4,000 invested in Microsoft,and $3,000 invested in Wal-Mart stock?
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Chapter 12: Estimating the Cost of Capital
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Q1) Explain how having different interest rates for borrowing and lending affects the CAPM and the SML.
Q2) Which of the following statements is NOT a difference between an exchange traded fund (ETF)and an index fund?
A) An ETF is structured to track a market index using a diversified basket of securities while an IMF focuses on tracking a market index using a portfolio comprising a defined group of securities within the index.
B) The structure of an ETF provides greater liquidity than an IMF since its market prices change throughout the day while an IMF is valued only one a day.
C) An ETF offers a daily disclosure of holdings while an IMF typically discloses through quarterly reports.
D) An IMF will distribute realized capital gains and losses more frequently than an IMF.
Q3) Monsters' required return is closest to:
A) 10.0%
B) 13.0%
C) 11.5%
D) 15.5%
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Chapter 13: Investor Behaviour and Capital Market
Efficiency
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Q1) Which of the following statements is false?
A) Because expected returns are not easy to estimate, each portfolio that is added to a multifactor model increases the difficulty of implementing the model.
B) The self-financing portfolio made from high minus low book-to-market stocks is called the high-minus-low (HML) portfolio.
C) The FFC factor specification was identified a little more than ten years ago. Although it is widely used in academic literature to measure risk, much debate persists about whether it really is a significant improvement over the CAPM.
D) A trading strategy that each year short sells portfolio S (small stocks) and uses this position to buy portfolio B (big stocks) has produced positive risk adjusted returns historically. This self-financing portfolio is widely known as the small minus big (SMB) portfolio.
Q2) Portfolio "B"
A) is less risky than the market portfolio.
B) is overpriced.
C) has a positive alpha.
D) falls above the SML.
Q3) What does the existence of a positive alpha investment strategy imply?
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Chapter 14: Financial Options
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Q1) ________,options on Canadian stocks and bonds were traded on the Montreal Exchange,which was centre of the Canadian Derivatives Exchange.
A) After 1999
B) Before 1973
C) After 2008
D) Before 2008
Q2) How many of the January 2009 call options are in-the-money?
A) 2
B) 4
C) 1
D) 3
Q3) Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation the term S refers to
A) the payoff of a zero coupon bond.
B) the strike price of the option.
C) the value of the call option.
D) the stock's current price.
Q4) Graph the payoff at expiration of a short position in a put option with a strike price of $20.
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Chapter 15: Option Valuation
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Q1) Using risk-neutral probabilities,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
Q2) Which of the following statements is false?
A) A replicating portfolio is a portfolio of other securities that has exactly the same value in one period as the option.
B) By using the Law of One Price, we are able to solve for the price of the option as long as we know the probabilities of the states in the binomial tree.
C) The binomial tree contains all the information we currently know: the value of the stock, bond, and call options in each state in one period, as well as the price of the stock and bond today.
D) The idea that you can replicate the option payoff by dynamically trading in a portfolio of the underlying stock and a risk-free bond was one of the most important contributions of the original Black-Scholes paper. Today, this kind of replication strategy is called a dynamic trading strategy.
Q3) Using risk-neutral probabilities,calculate the price of a two-year put option on Kinston stock with a strike price of $9.
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Chapter 16: Real Options
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Q1) Which of the following statements is false?
A) The profitability index rule of thumb raises the bar on the NPV to take into account the option to wait.
B) In practice, correctly modeling the sources of uncertainty and the appropriate dynamic decisions usually requires an extensive amount of time and financial expertise.
C) Some firms use the following rule of thumb: invest whenever the profitability index is below a specified level.
D) Instead of raising the bar on the NPV, the hurdle rate rule raises the discount rate.
Q2) Value can be created by ________ to resolve.
A) waiting for certainty
B) waiting for uncertainty
C) act on certainty
D) act on uncertainty
Q3) Which of the following is NOT a real option?
A) A stock option
B) An abandonment option
C) An investment timing option
D) An expansion option
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18
Chapter 17: Capital Structure in a Perfect Market
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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.The market value of Luther's non-cash assets is closest to:
A) $22 billion
B) $20 billion
C) $25 billion
D) $18 billion
Q2) What is a market value balance sheet and how does it differ from a book value balance sheet?
Q3) Suppose you own 10% of the equity of With.What is another portfolio you could hold that would provide you with the same exact cash flows?
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
Q5) Based upon the three comparable firms,what asset beta would you recommend using for your firm's new project?
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Chapter 18: Debt and Taxes
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Q1) If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff as an all equity firm would be closest to:
A) $73 million
B) $80 million
C) $115 million
D) $100 million
Q2) The total value of the levered firm exceeds the value of the firm without leverage due to the ________ value of the tax savings from debt.
A) market
B) book
C) present
D) current
Q3) In Canada and many other countries,interest income has historically been taxed ________ dividends or capital gains from equity.
A) equally to
B) less heavily than C) more heavily than
D) more deliberately than
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Chapter 19: Financial Distress, managerial Incentives, and Information
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Q1) Assume that EGI decides to raise the $100 million through the issuance of new shares prior to the release of the new video game.EGI's share price following the release of the new video game will be closest to:
A) $18.00
B) $19.00
C) $20.00
D) $16.00
Q2) The value of Luther without leverage is closest to:
A) $315 million
B) $300 million
C) $205 million
D) $340 million
Q3) The number of new shares that Kinston must issue to raise the capital needed to pay its debt obligation is closest to:
A) 4.3 million
B) 4.7 million
C) 5.0 million
D) 4.0 million
Q4) List five general categories of indirect costs associated with bankruptcy.
Page 21
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Chapter 20: Payout Policy
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Q1) Suppose that Iota is able to invest the $200 million in excess cash into a project that will increase future free cash flows by 30%.If you were advising the board,what course of action would you recommend: investing the $200 million in an expansion project that will raise future free cash flows by 30% or using the $200 million to repurchase shares? Which provides the higher stock price?
Q2) If Rockwood is able to repurchase shares prior to the market becoming aware of the new information regarding Rockwood's true value,then the number of shares outstanding following the repurchase is closest to:
A) 92 million
B) 10 million
C) 75 million
D) 90 million
Q3) The effective dividend tax rate for a one-year individual investor in 1999 is closest to:
A) 0%
B) 20%
C) 25%
D) 40%
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22
Chapter 21: Capital Budgeting and Valuation With Leverage
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Q1) When the firm keeps its interest payments to a target fraction of its FCF,we say it has a(n)________ interest coverage ratio.
A) constant
B) average
C) variable
D) zero
Q2) Which of the following statements is false?
A) The WACC can be used throughout the firm as the company-wide cost of capital for new investments that are of comparable risk to the rest of the firm and that will not alter the firm's debt-equity ratio.
B) A disadvantage of the WACC method is that you need to know how the firm's leverage policy is implemented to make the capital budgeting decision.
C) The intuition for the WACC method is that the firm's weighted average cost of capital represents the average return the firm must pay to its investors (both debt and equity holders) on an after-tax basis.
D) To be profitable, a project should generate an expected return of at least the firm's weighted average cost of capital.
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Chapter 22: Valuation and Financial Modelling: a Case Study
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Q1) The cash multiple does not depend on the amount of time it takes to receive the cash,nor does it account for the risk of the investment.It is therefore useful only for comparing deals
A) with different time horizons and different risk levels.
B) with similar time horizons and different risk levels.
C) with similar time horizons and similar risk levels.
D) with different time horizons and similar risk levels.
Q2) According to the Canadian Institute of Chartered Accountants (CICA)handbook,a firm's goodwill is not necessarily amortized but it is subject to ________ at least once a year.
A) an impairment test
B) an impairment charge
C) an asset valuation
D) a capital asset valuation
Q3) What is the purpose of the sensitivity analysis?
Q4) As an intangible asset,goodwill is ________ over time as its value ________.
A) amortized; grows
B) not amortized; declines
C) amortized; declines
D) not amortized; grows
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Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Underpricing in Canada is ________,but the magnitude is ________ in many other countries.
A) significant; not as large as B) insignificant; not as large as C) insignificant; as large as D) significant; as large as
Q2) In Canada,________ usually takes the lead in reviewing and approving the preliminary prospectus.The other provincial securities commissions usually follow
A) the Ontario Securities Commission (OSC); Ontario's decision
B) the Toronto Stock Exchange (TSX); TSX's decision
C) the Canadian Securities Administrators (CSA); CSA's decision
D) the relevant provincial securities commission; the relevant provincial's decision
Q3) Assuming that this is the venture capitalist's first investment in your firm,the post-money valuation of your shares are closest to:
A) $5.0 million
B) $12.5 million
C) $4.0 million
D) $2.5 million
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Chapter 24: Debt Financing
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Q1) Treasury securities that are semi-annual coupon bonds with original maturities of between 1 and 10 years are called
A) Treasury bonds.
B) Treasury bills.
C) Treasury notes.
D) TIPS.
Q2) Which of the following statements is false?
A) Before the call date, investors anticipate the optimal strategy that the issuer will follow, and the bond price reflects this strategy.
B) The yield to maturity of a callable bond is calculated as if the bond were called at the earliest opportunity.
C) A callable bond will trade at a lower price (and therefore a higher yield) than an otherwise equivalent non-callable bond.
D) The price of a callable bond can be low when yields are high, but does not rise above the call value when the yield is low.
Q3) What is the Yield to Maturity (YTM)on this bond?
Q4) What is the Yield to Call (YTC)on this bond?
Q5) What is the Yield to Call (YTC)on this bond?
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Chapter 25: Leasing
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Q1) The risk of the lease payments is ________ the risk of secured debt,so it is reasonable to discount the lease payments at the firm's secured borrowing rate.
A) equal to B) no less than C) no greater than D) greater than
Q2) Which of the following statements regarding leases and bankruptcy is false?
A) Operating and true tax leases are generally viewed as true leases by the courts, whereas capital and non-tax leases are more likely to be viewed as security interests.
B) By retaining ownership of the asset, the lessor has the right to repossess it if the lease payments are not made, even if the firm seeks bankruptcy protection.
C) If a lease contract is characterized as a true lease in bankruptcy, the lessor is in a somewhat superior position compared to a lender if the firm defaults.
D) If the lease is classified as a true lease in bankruptcy, then the lessee retains ownership rights over the asset.
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Chapter 26: Working Capital Management
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Q1) Which of the following money market investments is a short-term debt obligation of the Canadian government?
A) Treasury Bill
B) Repurchase Agreement
C) Commercial Paper
D) Certificates of Deposit (CD)
E) Banker's Acceptance
Q2) Calculate the number of days in Luther's Operating Cycle.
Q3) Which of the following money market investments is short-term debt issued by a bank with a minimum denomination of $100,000?
A) Treasury Bill
B) Banker's Acceptance
C) Repurchase Agreement
D) Commercial Paper
E) Certificates of Deposit (CD)
Q4) Luther's inventory days is closest to:
A) 32 days
B) 59 days
C) 39 days
D) 42 days
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Chapter 27: Short-Term Financial Planning
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Q1) As LIBOR is a rate paid by banks with ________,most firms will borrow at a rate that ________ LIBOR.
A) the highest credit quality; is below B) the lowest credit quality; exceeds C) the lowest credit quality; is below D) the highest credit quality; exceeds
Q2) Which of the following statements is false?
A) If a factoring arrangement is with recourse, the factor will pay the firm the amount due regardless of whether the factor receives payment from the firm's customers or not.
B) In a factoring of accounts receivable arrangement, the firm sells receivables to the lender (i.e., the factor), and the lender agrees to pay the firm the amount due from its customers at the end of the firm's payment period.
C) Businesses can also obtain short-term financing by using secured loans, which are loans collateralized with short-term assets-most typically the firm's accounts receivable or inventory.
D) Both the interest rate and the factor's fee vary depending on such issues as the size of the borrowing firm and the dollar volume of its receivables.
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Chapter 28: Mergers and Acquisitions
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Q1) This period is known for known for "strategic" or "global" deals that were more likely to be friendly and to involve companies in related businesses; these mergers often were designed to create strong firms on a scale that would allow them to compete globally:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
Q2) If Martin pays no premium to acquire Luther,what will the earnings per share be after the merger?
Q3) For most investors an investment in the stock market is a ________ investment.
A) risk-free
B) positive-NPV
C) zero-NPV
D) negative-NPV
Q4) What is a white knight?
Q5) Assume that Martin pays no premium to acquire Luther.Calculate Martin's price-earnings (P/E)ratio both pre- and post-merger.
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Chapter 29: Corporate Governance
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Q1) Which of the following statements regarding auditors is false?
A) Most auditors have a longstanding relationship with their audit clients; this extended relationship and the auditors' desire to keep the lucrative auditing fees makes auditors less willing to challenge management.
B) Most accounting firms have developed large and extremely profitable consulting divisions. Obviously, if an audit team refuses to accommodate a request by a client's management, that client will be less likely to choose the accounting firm's consulting division for its next consulting contract.
C) Auditing firms are supposed to ensure that a company's financial statements accurately reflect the financial state of the firm.
D) In the post Sarbanes-Oxley world, accounting firms are no longer allowed to offer both audit and non-audit services to the same firm.
Q2) Directors who are employees,former employees,or family members of employees are called
A) Managing Directors.
B) Independent Directors.
C) Inside Directors.
D) Gray Directors.
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Chapter 30: Risk Management
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Q1) The risk that arises because the value of the futures contract will not be perfectly correlated with the firm's exposure is called
A) commodity price risk.
B) basis risk.
C) liquidity risk.
D) speculation risk.
Q2) Which of the following statements is false?
A) We can measure a firm's sensitivity to interest rates by computing the duration of its balance sheet.
B) A firm's market capitalization is determined by the difference in the market value of its assets and its liabilities.
C) By restructuring the balance sheet to increase its duration, we can hedge the firm's interest rate risk.
D) All of the above are true.
Q3) What is the actuarially fair cost of full insurance?
Q4) What are some of the disadvantages of long-term supply contracts?
Q5) Assuming that your firm will purchase insurance,what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
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Chapter 31: International Corporate Finance
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Q1) How do we make adjustments when a project has inputs and outputs in different currencies?
Q2) After the Irish taxes are paid,the amount of the earnings before interest and after taxes in dollars from the Ireland operations is closest to:
A) $5.1 million
B) $20.5 million
C) $35.6 million
D) $29.5 million
Q3) After the Japanese taxes are paid,the amount of the earnings before interest and after taxes in dollars from the Japanese operations is closest to:
A) $20.5 million
B) $29.5 million
C) $5.1 million
D) $50.0 million
Q4) What is the dollar present value of the project?
Q5) What is the pound present value of the project?
Q6) Calculate the pound denominated cost of capital for Luther's project.
Q7) What conditions cause the cash flows of a foreign project to be affected by exchange rate risk?
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