Introduction to Corporate Finance Exam Preparation Guide
Course Introduction
Introduction to Corporate Finance provides students with a foundational understanding of the principles and practices that underpin financial decision-making within corporations. The course explores key topics such as time value of money, risk and return, capital budgeting, financial statement analysis, cost of capital, and capital structure. Through real-world case studies and practical problem-solving, students gain insights into how companies evaluate investment opportunities, manage financial resources, and strive to maximize shareholder value. This course equips students with essential skills and knowledge applicable to a range of careers in business, finance, and investment.
Recommended Textbook
Fundamentals of Corporate Finance 6th Canadian Edition by Richard A Brealey
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Chapter 1: Goals and Governance of the Firm
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Sample Questions
Q1) Which of the following appears to be the most appropriate goal for corporate management?
A) maximizing market value of the company's shares.
B) maximizing the company's market share.
C) maximizing the current profits of the company.
D) minimizing the company's liabilities.
Answer: A
Q2) Which of the following would correctly differentiate general partners from limited partners in a limited partnership?
A) general partners have more job experience.
B) general partners have an ownership interest.
C) general partners are subject to double taxation.
D) general partners have unlimited personal liability.
Answer: D
Q3) An example of a firm's financing decision would include:
A) acquisition of a competitive firm.
B) how much to pay for a specific asset.
C) the issuance of ten-year versus twenty-year bonds.
D) whether or not to increase the price of its products.
Answer: C
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Chapter 2: Financial Markets and Institutions
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Sample Questions
Q1) Only the IPOs for large corporations are sold in primary markets.
A)True
B)False
Answer: False
Q2) Which of the following factors contributed to the financial crisis of 2007-2009?
A) Greece's debt
B) Subprime mortgages
C) Drought conditions in the mid-west
D) Both Greece's debt and subprime mortgages
Answer: D
Q3) Identify a minimum of four major market factors that contributed to the financial crisis of 2007-2009.
Answer: 1.The Federal Reserve for its easy money policy
2.The US government for encouraging banks to expand credit for low income housing
3.The rating agencies for providing triple-A ratings for mortgage bonds that shortly afterward went into default
4.Bankers for promoting and reselling subprime mortgages.
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Chapter 3: Accounting and Finance
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Sample Questions
Q1) If the value of a firm's net fixed assets equals the value of the accumulated depreciation,from an accounting context the fixed assets are:
A) new.
B) fully depreciated.
C) one-half depreciated.
D) equal in value to the firm's current assets.
Answer: C
Q2) Accounting practices are currently standardized across all countries.
A)True
B)False
Answer: False
Q3) Suppose Dee's just acquired the assets of Flo's Flowers.The book value of Flo's Flowers assets was $68,000 but Dee's paid a total of $75,000.The additional $7,000 paid by Dee's will be recorded on Dee's balance sheet as:
A) accounts payable.
B) goodwill.
C) other current assets.
D) property, plant, and equipment.
Answer: B
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Chapter 4: Measuring Corporate Performance
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Sample Questions
Q1) Market value added is the difference between the market value of the firm's equity and its book value.
A)True
B)False
Q2) In the past year,TVG had revenues of $3 million,cost of goods sold of $2.5 million,and depreciation expense of $200,000.The firm has a single issue of debt outstanding with a face value of $1 million,market value of $.92 million,and a coupon rate of 8%.What is the firm's times interest earned ratio?(Use value in dollars)
A) 3.75
B) 2.98
C) 2.80
D) 3.40
Q3) EVA is the net profit of the firm adjusted for the cost of capital. A)True B)False
Q4) The income statement of a firm shows the value of its assets and liabilities over a specified period of time.
A)True B)False
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Chapter 5: The Time Value of Money
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Q1) "Give me $5,000 today and I'll return $10,000 to you in 5 years," offers the investment broker.To the nearest percent,what annual interest rate is being offered?
A) 12.29%
B) 13.67%
C) 14.87%
D) 12.84%
Q2) The salesperson offers,"Buy this new car for $25,000 cash or,with an appropriate down payment,pay $500 per month for 48 months at 8% interest,compounded monthly." Calculate the "appropriate" down payment.
A) $1,000.00
B) $4,519.04
C) $5,127.24
D) $8,000.00
Q3) To calculate present value,we discount the future value by some interest rate r,the discount rate.
A)True
B)False
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Chapter 6: Valuing Bonds
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Q1) An investor buys a 10-year $1,000,7% coupon bond for $1,050,holds it for 1 year,and then sells it for $1,040.What was the investor's rate of return?
A) 5.71%
B) 6.00%
C) 6.67%
D) 7.00%
Q2) Consider a 3-year bond with a par value of $1,000 and an 8% annual coupon.If interest rates change from 8% to 6% the bond's price will:
A) increase by $51.54.
B) decrease by $51.54.
C) increase by $53.46.
D) decrease by $53.46.
Q3) What is the coupon rate for a bond with 3 years until maturity,a price of $1,053.46,and a yield to maturity of 6%? Interest is paid annually.
A) 6%
B) 8%
C) 10%
D) 11%
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Chapter 7: Valuing Stocks
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Q1) In a valuation of a non-constant dividend growth stock,the terminal value represents the:
A) point at which the present value of future dividends equals zero.
B) maturity date of the stock.
C) present value of future dividends from that point onwards.
D) highest value that the stock will attain.
Q2) What happens to a firm that reinvests its earnings at a rate equal to the firm's required return?
A) its stock price will remain constant
B) its stock price will increase by the sustainable growth rate
C) its stock price will decline unless dividend payout ratio is zero
D) its stock price will decline unless plowback rate exceeds required return
Q3) Cash dividends are offered to shareholders in lieu of increasing the stock's price. A)True B)False
Q4) How can an analyst be credible in stating that the value of a stock is equal to the discounted value of all future dividends when a company may pay dividends indefinitely and it is virtually impossible to predict dividends beyond some reasonable horizon?
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Chapter 8: Net Present Value and Other Investment Criteria
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Q1) According to the NPV rule,all projects should be accepted if NPV is positive when discounted at the:
A) internal rate of return.
B) opportunity cost of capital.
C) risk-free interest rate.
D) accounting rate of return.
Q2) When managers select correctly from among mutually exclusive projects,they:
A) may give up rate of return for NPV.
B) may give up NPV for rate of return.
C) have a tendency to select the largest project.
D) focus on payback method to avoid conflicting signals.
Q3) Unlike using IRR,selecting projects according to their NPV will always lead to a correct accept-reject decision.
A)True
B)False
Q4) Borrowing and lending projects usually can be distinguished by whether:
A) they have positive or negative IRRs.
B) the time-zero cash flow is positive or negative.
C) their IRR increases as the discount rate increases.
D) their rate of return is high or low.
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Chapter 9: Using Discounted Cash Flow Analysis to Make Investment Decisions
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Q1) The total depreciation tax shield equals the product of depreciation and the tax rate. A)True
B)False
Q2) Offer examples to confirm that firms do experience opportunity costs,even when cash payments are not explicitly made.
Q3) Assume your firm has an unused machine that originally cost $75,000,has a book value of $20,000,and is currently worth $25,000.Ignoring taxes,the correct opportunity cost for this machine in capital budgeting decisions is:
A) $75,000.
B) $25,000.
C) $20,000.
D) $5,000.
Q4) When an asset class is terminated,there will be recaptured depreciation when the adjusted cost of disposal from UCC of the asset class is a negative balance.
A)True
B)False
Q5) How do changes in working capital affect project cash flows?
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Chapter 10: Project Analysis
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Q1) Which of the following sources would most likely be responsible for persistent "project cost over-runs"?
A) rapidly rising inflation
B) delays in obtaining contracts and permits
C) lack of raw materials
D) forecasting bias by the sponsoring manager
Q2) The inputs that are most worth refining before you commit to a project are the ones that have the greatest potential to alter project NPV.
A)True
B)False
Q3) A firm with 60 percent of sales going to variable costs,$1.5 million fixed costs,and $500,000 depreciation would show what accounting profit with sales of $3 million? Ignore taxes.
A) Zero loss
B) $370,000 loss
C) $666,667 Loss
D) $800,000 loss
Q4) Describe decision trees,including how they can be useful and how they can be risky.
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Chapter 11: Introduction to Risk, Return, and the Opportunity
Cost
of Capital
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Q1) If one portfolio's variance exceeds that of another portfolio,its standard deviation will also be greater than that of the other portfolio.
A)True
B)False
Q2) What percentage return is achieved by an investor who purchases a stock for $30,receives a $1.50 dividend,and sells the share one year later for $28.50?
A) -5 percent
B) 0 percent
C) 5 percent
D) 10 percent
Q3) When high growth is expected in the economy,an investor should receive higher returns from:
A) cyclical investments.
B) countercyclical investments.
C) stocks with negative correlations.
D) stocks with low standard deviations.
Q4) Explain the concepts of unique risk,market risk,and how the total level of portfolio risk can change by adding additional securities.
Page 13
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Chapter 12: Risk, Return, and Capital Budgeting
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Sample Questions
Q1) What two elements are represented in security returns?
A) a premium for market risk and for unique risk
B) a premium for unique risk and a premium for firm-specific risk
C) a premium for diversification and a premium for portfolio risk
D) a premium for time value of money and a premium for market risk
Q2) A proposed investment must earn at least as much as the ______ if it is to be deemed acceptable.
A) Company cost of capital.
B) Risk-free rate.
C) Market risk premium.
D) Project cost of capital.
Q3) When Treasury bills yield 7.0% and the expected return on the market is 16%,then the risk premium on an asset is equal to:
A) 7.0%.
B) 16.0%.
C) 9.0% times the asset's Beta.
D) 8.0% plus the risk-free rate.
Q4) If each scenario is equally likely,find the expected rate of return on the market portfolio and on each stock.
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Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Q1) The cost of capital must be based on the securities' book values. A)True
B)False
Q2) Free cash flow is calculated by:
A) earnings + operating cash flow.
B) investment in long term assets and working capital plus operating cash flow.
C) operating cash flow minus investment in long term assets and working capital..
D) EBIT + Operating cash flow.
Q3) Why can it be incorrect to evaluate all capital budgeting proposals at the firm's current weighted-average cost of capital?
Q4) The riskiness of equity securities typically exceeds that of debt securities for firms. A)True
B)False
Q5) Why are investors interested in free cash flow?
Q6) New projects should only be undertaken by firms if they have the same risk as existing assets.
A)True
B)False
Page 15
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Chapter 14: Introduction to Corporate Financing and Governance
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Sample Questions
Q1) Discuss why more firms are turning to internally generated funds to finance new projects.
Q2) The call provision of callable bonds comes at the expense of bond holders,for it limits investors' capital gain potential.
A)True
B)False
Q3) Which of the following is the holder of a warrant allowed to do prior to a specified date?
A) convert debt into a specified number of shares.
B) sell common shares at a predetermined price.
C) exchange stock for bonds at a specified price.
D) purchase shares at a predetermined price.
Q4) In what ways is preferred stock like long-term debt? In what ways is it like common stock?
Q5) Junk bonds represent debt that was issued to:
A) finance the acquisition of used manufacturing equipment.
B) firms in countries with high rates of inflation.
C) offer higher yields and less security than other debt
Page 16
D) firms that have defaulted on their dividend payments
Q6) What does it mean to say that financing is a zero-NPV transaction?
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Chapter 15: Venture Capital, IPOs, and Seasoned Offerings
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Q1) A firm decides to raise $1 million with a rights issue.The issue will be based on a subscription price of $20,with 50,000 shares to be issued.Assume the shares outstanding currently trade for $35.Calculate the Ex-rights price of the company stock.
Q2) The allowance of POP registration in Canada is likely to have increased:
A) the cost of issuing new securities.
B) the profits of venture capitalists.
C) competition among underwriters.
D) the underpricing of securities.
Q3) If an underwriter charges the public $40 per share for a new issue after having promised the issuer $38 per share,the spread per share is:
A) $1.00.
B) $2.00.
C) $38.00.
D) $40.00.
Q4) Detail the difference between a prospectus and a red herring prospectus?
Q5) Economies of scale are apparent in the issuance of securities.
A)True
B)False
Q6) Discuss the potential agency issue with managers' issuance of new equity.
Page 18
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Chapter 16: Debt and Payout Policy
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Q1) Ignoring taxes,a firm's weighted-average cost of capital is equal to:
A) its expected return on assets.
B) its expected return on equity.
C) the sum of expected return on equity and expected return on debt.
D) its expected return on assets times the debt-equity ratio.
Q2) A firm has an expected return on equity of 15% and an after-tax cost of debt of 10%.What debt-equity ratio should be used in order to keep the WACC at 11%?
A) 1.00
B) 2.00
C) 3.00
D) 4.00
Q3) When a corporation issues permanent debt,the value of all its securities:
A) increases by the present value of the tax shield.
B) decreases by the present value of the tax shield.
C) increases by the annual interest tax shield.
D) decreases by the annual interest tax shield.
Q4) Debt financing affects neither the operating risk nor the business risk of the firm.
A)True
B)False
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Chapter 17: Leasing
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Q1) Financial leases cover the entire economic life of the asset and are not cancellable.
A)True
B)False
Q2) The appropriate discount rate for financial lease analysis is:
A) the after-tax cost of equity.
B) the lessee's weighted average cost of capital.
C) the lessor's required rate of return.
D) the lessee's after-tax cost of secured debt.
Q3) The lessee in a financial lease bears the most of the same risks and rewards as ownership except:
A) he doesn't know how large his lease payments are.
B) he has no tax shelter for his cash outflows.
C) he has no access to capital gain from an extraordinary salvage value.
D) he can cancel his obligations to a lessor with 30 days' notice.
Q4) A sale and leaseback arrangement transfers ownership from a user to a lessor who then leases the asset back to the former owner.
A)True
B)False
Q5) Provide a critique of two weak or dubious reasons for leasing.
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Chapter 18: Payout Policy
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Q1) Those economists feeling that low dividend payouts will increase share price focus on:
A) the difficulty in predicting earnings.
B) superior reinvestment opportunities.
C) tax differentials between dividends and capital gains.
D) the cost of borrowing to maintain high payouts.
Q2) What capital gain must a non-dividend-paying stock attain in order for a corporate investor in the 35% tax bracket to be indifferent to a stock paying an 8% dividend but having no capital gain? Assume 30% tax rate on dividends.
A) 8.00%
B) 9.29%
C) 11.02%
D) 12.31%
Q3) Which of the following is the order in which key dividend dates occur:
A) declaration, with-dividend, record, ex-dividend, payment.
B) declaration, with-dividend, ex-dividend, record, payment.
C) record, declaration, with-dividend, payment, ex-dividend.
D) with-dividend, ex-dividend, record, declaration, payment.
Q4) Discuss the concept of dividend signaling.
Q5) Discuss the concept of dividend "smoothing."
Page 21
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Chapter 19: Long-Term Financial Planning
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Q1) How will a percentage of sales models treat cost of goods sold if sales revenues are expected to grow by 20% to $1 million? Cost of goods sold will:
A) Grow at a slower rate than sales
B) Remain proportionate to sales
C) Be forecast to increase at the rate of inflation
D) Increase to $800,000
Q2) A firm's internal growth rate of 10% means that:
A) Sales can grow by 10% before external equity is needed
B) Retained earnings can increase by 10% before total assets will change
C) External capital will not be required unless sales growth exceeds 10%
D) Debt can increase by 10% before retained earnings will fall
Q3) Which of the following might indicate the correct choice of a plug figure if a financial plan shows sources of funds to be $100,000 and uses of funds to be $90,000?
A) External debt must increase by $10,000
B) Dividend payments must decrease by $10,000
C) Cash balances must increase by $10,000
D) The capital budget must decrease by $10,000
Q4) Why is it uncommon to expect assets to change proportionately with sales?
Q5) Why do current or fixed assets often not vary proportionately with sales?
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Chapter 20: Short-Term Financial Planning
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Q1) A firm needs spare cash because during economic downturns,sales may fall below expectations while outflows could prove higher than was budgeted.Firms sell their accounts receivable at a discount for the purpose of:
A) finance motive
B) transactions motive
C) speculative motive
D) obtaining short-term financing
Q2) A firm's inventory and accounts payable periods are 80 and 42 days respectively.How long can the firm's receivables period be in order to have no longer than a 65 day cash conversion cycle?
A) 27 days
B) 38 days
C) 57 days
D) 103 days
Q3) Firms are often known to pay commitment fees to banks for the privilege of receiving a line of credit.Does it make sense for a firm to pay for something that,at least at the present time,it does not know whether it will use?
Q4) How does long-term financing policy affect short-term financing requirements?
Q5) List and explain the four forecast uses of cash.
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Chapter 21: Cash and Inventory Management
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Q1) What is the total carrying cost for an inventory of 200 widgets if the per-widget carrying cost is $4,the cost per order is $14,and there are 5 orders per year?
A) $400
B) $470
C) $800
D) $870
Q2) The Quick Corp.has implemented procedures to cut 1.5 days from their cash collection process.Annual sales (all charge sales)are $30 million and the opportunity cost of funds is 9 percent.What is the value of the annual savings,and how much would the savings be worth if the speed-up in collections can be considered permanent?
Q3) What is the payment float?
Q4) A firm using Baumol's model will do one of the following if the interest rate on short-term securities went up.
A) increase the average cash balance
B) increase the collection period
C) decrease the collection period
D) decrease the average cash balance
Q5) What is the availability float?
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Chapter 22: Credit Management and Collection
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Q1) Why will sellers be less reluctant to grant credit under terms of a banker's acceptance? How do the acceptances work,in general?
Q2) Which of the following typically justifies the offering of season dating?
A) The firm earns interest on the receivables
B) Product demand is increased during the low-sales months of the year
C) The firm is experiencing cash flow difficulties
D) The firm develops repeat business
Q3) Select the earliest date below which does not deserve a cash discount if the terms of a January 1 sale are 2/10,EOM,net 60?
A) January 2
B) January 12
C) February 2
D) February 12
Q4) Which of the following financial ratios has the highest weight in Altman's Z score estimation?
A) Working capital/total assets
B) Retained earnings/total assets
C) EBIT/total assets
D) Sales/total assets
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Chapter 23: Mergers, Acquisitions, and Corporate Control
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Q1) A merger between two firms in a similar industry is an example of vertical merger.
A)True
B)False
Q2) If Snapper Lawnmowers were to acquire Briggs and Stratton (gasoline-powered engines),the merger would be:
A) a conglomerate.
B) a divestiture.
C) horizontal.
D) vertical.
Q3) Agency cost occurs when managers or directors take actions adverse to shareholders' interest.
A)True
B)False
Q4) Mergers may provide reductions in average production cost as a result of:
A) increased market share.
B) a more efficient management.
C) economies of scale.
D) diversification.
Q5) Who is typically the primary beneficiary(ies)in a merger?
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Chapter 24: International Financial Management
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Q1) The international Fisher effect predicts that differences in nominal interest rates between countries reflect differences in:
A) real rates of interest.
B) purchasing power parity.
C) the standard of living.
D) expected inflation.
Q2) Where would you prefer to invest,and why,if nominal rates are 10% in Canada and 25% in Holland,while the expected rates of inflation are 5% and 19% respectively? Assume investments of equal risk.
A) Invest in Holland due to higher nominal rate.
B) Invest in Canada; real return is 1.1% higher.
C) Invest in Canada; real return is 0.1% higher.
D) Invest in Holland; real return is 0.28% higher.
Q3) Forward rates are always equal to the actual future exchange rates.
A)True
B)False
Q4) How do we perform an NPV analysis for projects with cash flows in foreign currencies?
Q5) Explain the expectations theory of exchange rates.
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Chapter 25: Options
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Q1) Which of the following changes will decrease the value of a call option?
A) An increase in stock price.
B) An increase in strike price.
C) An increase in stock price volatility.
D) An increase in interest rates.
Q2) Calculate the return on exercising a put option that was purchased for $10,with an exercise price of $85.The stock price at expiration is $81.
A) (60%)
B) 60%
C) 30%
D) (30%)
Q3) Which is the best definition of a call option?
A) The right to buy an asset at a fixed price during a particular time period.
B) The right to sell an asset at a fixed price during a particular time period.
C) A security that gives the holder the right to purchase shares of a stock at a fixed price over a period of time.
D) The act of buying or selling the underlying asset via the option contract.
Q4) Why would bondholders be willing to pay more for bonds that contain warrants?
Q5) What options may be provided in financial securities?
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Chapter 26: Risk Management
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Q1) A farmer who sells a futures contract is betting that prices will _____ at the expiration of the contract.
A) Decrease
B) Increase
C) Remain constant
D) Guarantee high profits
Q2) At the expiration of a futures contract,the futures price will be:
A) greater than spot price.
B) equal to the spot price.
C) less than the spot price.
D) more than the forward price.
Q3) The derivatives market is characterized by:
A) stability.
B) innovation.
C) riskiness.
D) private deals.
Q4) Put options can be thought of as insurance policies for commodity producers.
A)True
B)False
Q5) Discuss the statement,"managers are not paid to avoid risk".
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