Corporate Finance Wrong MC Questions
Any bond that is issued at a discount is known as A) a pure discount bond. B) a zero-coupon bond. C) an original issue discount bond. D) a premium bond.
C
Consider the aggregate balance sheet for manufacturing corporations in the United States. Which of the following sources of financing plays the largest role? A) Current liabilities B) Long-term debt C) Stockholders' equity D) Each of the sources plays an equal role.
C
In the United States, the premium that an investor needed to pay to gain voting control was what percentage of firm value? A) 29 percent. B) 36 percent. C) 2 percent. D) 32 percent
C
36) Last year Foley Inc. reported net fixed assets of $400, net working capital of $100, net income of $120, dividends of $70, and earnings retained in the period of $50. What is Foley Inc.'s internal growth rate? A) 17.5 percent B) 30.0 percent C) 10.0 percent D) 12.5 percent
C Internal growth rate: 50/500 = 10%
3) If the discount rate on a bond is 5 percent and the expected payment in year 1 is $985, calculate the price of the bond. A) $1,050 B) $985 C) $938.10 D) $1,000
C PV = 985/(1.05) = 938.10
A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0). You expect the project to produce sales revenue of $120,000 per year for three years. You estimate manufacturing costs at 60 percent of revenues. (Assume all revenues and costs occur at year-end, i.e., t = 1, t = 2, and t = 3). The equipment depreciates using straight-line depreciation over three years. At the end of the project, the firm can sell the equipment for $10,000 and also recover the investment in net working capital. The corporate tax rate is 21 percent and the cost of capital is 15 percent. Cash flows from the project are
CF0: −100,000; CF1: 44,220; CF2: 44,220; CF3: 62,120
13) The following are dubious reasons for mergers: I) diversification; II) increase earnings per share (EPS); III) lower financing costs; IV) industry consolidation A) I only B) II and IV only C) III and IV only D) I, II, and III only
D
23) Asset sales: I) are perceived as good news for investors of the selling firm; II) generally result in the assets being employed more productively after the sale; III) transfer business units to companies that can manage them more efficiently; A) I only B) I and II only C) II and III only D) I, II, and III
D
25) When firms prepare a financial plan, they use the following: A) Guessing simulations. B) Guessing simulations and sensitivity analysis. C) Guessing simulations, sensitivity analysis, and scenario analysis. D) Sensitivity analysis and scenario analysis
D
29) Which measure would be most useful in comparing the operating profitability of two firms in different industries? A) Net profit margin B) Return on equity C) Sales to total assets D) Return on assets
D
3) A "samurai bond" is a bond A) sold by a company from Japan. B) sold in the United States by a company from Japan. C) sold in Japan by a local company. D) sold in Japan by a company from some other country
D
32) Which of the following statements is (are) true of limited partnerships? A) Limited partners enjoy limited liability but do not participate in management. B) Generally, limited partners put up most of the money. C) Generally, limited partners are institutional investors. D) All of these statements are true of limited partnerships.
D
5) Inventory consists of: A) finished goods. B) raw material and finished goods. C) raw material, work in process, and prepaid rent. D) raw material, work in process, and finished goods
D
50) Examples of shark-repellent charter amendments include A) supermajority. B) waiting period. C) supermajority and waiting period. D) supermajority, waiting period, restricted voting rights, and staggered board
D
51) As a pre-offer defensive maneuver, existing bondholders can demand repayment if there is a change of control as a result of a hostile takeover. These bonds are an example of: A) greenmail. B) a "scorched earth" policy. C) crown jewels. D) a poison put.
D
53) Takeover defenses appear to favor A) stockholders. B) workers. C) creditors. D) managers.
D
7) According to SEC Rule 144A, A) bonds issued through private placements can be bought and sold by institutional investors. B) SEC registration is not needed for privately placed bonds. C) SEC registration is required of all securities issued in the United States. D) bonds issued through private placements can be bought and sold by institutional investors and SEC registration is not needed for privately placed bonds
D
All else equal, which of the following features will increase the value of a convertible bond? A) The risk-free interest rate is higher. B) The conversion ratio is higher. C) The conversion price is lower. D) All of the features increase the value.
D
As a provider of funds to a corporation, owning which of the following corporate securities will give you the most control rights? A) Short-term bank loan B) Long-term bond C) Preferred stock D) Common stock
D
During which year have U.S. nonfinancial firms raised positive net equity? A) 2014 B) 2015 C) 2016 D) Net new equity has been negative from 2014 to 2017
D
In the United Sates, who holds the smallest portion of corporate equities? A) Households B) Pension funds C) Mutual funds D) Insurance companies
D
Leveraged buyouts (LBOs) almost always involve which of the following? I) a large part of the purchase price is financed by debt; II) most of the issued debt is below investment grade (i.e., junk); III) the firm goes private and its shares are no longer traded on the open market A) I only B) II only C) I and II only D) I, II, and III
D
Lowering the debt-equity ratio of the firm can change the firm's I) financial leverage; II) cost of equity; III) cost of debt; IV) effective tax rate A) II and III only B) I only C) I, II, and III only D) I, II, III, and IV
D
The law of conservation of value implies that I) the mix of common stock and preferred stock does not affect the value of the firm; II) the mix of long-term and short-term debt does not affect the value of the firm; III) the mix of secured and unsecured debt does not affect the value of the firm A) I only B) II only C) III only D) I, II, and III
D
The trust company for a bond issue represents the A) managers of the firm. B) firm's shareholders. C) firm's board of directors. D) firm's bondholders.
D
16) Given are the following data for year 1: Profits after taxes = $20 million; Depreciation = $6 million; Interest expense = $4 million; Investment in fixed assets = $12 million; Investment in working capital = $4 million. The corporate tax rate is 25 percent. Calculate the free cash flow (FCF) for year 1. A) $4 million B) $6 million C) $8 million D) $13 million
D FCF = 20 + 6 + (1 − 0.25) x 4 − 12 − 4 = $13 million
A firm has issued $5 par value preferred stock that pays a $0.80 annual dividend. The stock currently sells for $9.50. In calculating WACC, what should one use for the value of the firm's preferred stock? A) $0.80 B) $4.20 C) $5.00 D) $9.50
D USE MARKET VALUE
20) Companies A and B are valued as follows: A: Number of shares 2,000 Earnings per share $ 10 Share price $ 100 B: Number of shares 1,000 Earnings per share $ 10 Share price $ 50 What is the cost of the merger? A) zero B) $2,000 C) $8,000 D) $4,000
Explanation: PVAB = $200,000 + $50,000 + $20,000 = $270,000 Price per share = $270,000/$2,500 = 108 Cost = (108)(500) − 50,000 = 4,000.
T/F: Diversification is a very sensible reason for two companies to merge.
False
T/F: In a private-equity partnership arrangement, the general partners put up most of the money but receive a management fee and get a carried interest in the fund's profits.
False
T/F: Supermajorities give shareholders more control over the firm.
False
49) Eurobonds are almost always denominated in euros.
Fasle
20) Companies A and B are valued as follows: A: Number of shares 2,000 Earnings per share $ 10 Share price $ 100 B: Number of shares 1,000 Earnings per share $ 10 Share price $ 50 Company A now acquires B by offering one (new) share of A for every two shares of B (that is, after the merger, there are 2,500 shares of A outstanding). If investors are aware that there are no economic gains from the merger, what is the price-earnings ratio of A's stock after the merger? A) 7.5 B) 8.3 C) 10 D) 5
(2000*10 + 1000*10)/2500 = 12 100/12 = 8.3
The average yield spread based on promised yield on Aaa bonds rated by Moody's and the yield on Treasuries is about
1%
14) Firm A has a value of $100 million and Firm B has a value of $70 million. Merging the two would enable cost savings with a present value of $20 million. Firm A purchases Firm B for $75 million. What is the gain from this merger? What is the cost? What is the gain to shareholders?
20 5 15
If a firm permanently borrows $100 million at an interest rate of 8 percent, what is the present value of the interest tax shield? (Assume that the marginal corporate tax rate is 21 percent.)
21. million
A corporation has 1,000,000 shares outstanding and 10 directors are up for election. If the stock features cumulative voting, approximately how many shares do you have to muster in order to guarantee yourself a place on the board of directors? (Ignore possible ties.)
500k
15) Assume the following data: EBIT = 100; Depreciation = 40; Interest = 20; Dividends = 10. Calculate the cash coverage ratio.
7 Cash coverage ratio = (100 + 40)/20 = 7
Suppose that your firm's current unlevered value, V*, is $800,000, and its marginal corporate tax rate is 21 percent. Also, you model the firm's PV of financial distress as a function of its debt level according to the relation: PV of financial distress = 800,000 × (D/V*)2. What is the firm's levered value if it issues $200,000 of perpetual debt to buy back stock?
792,000
26) A privatization is a A) sale of a government-owned company to private investors. B) sale of private companies to the government. C) sale of a publicly traded company to private investors. D) sale, by a private equity fund's limited partners, of their partnership stakes.
A
27) The flow to equity method provides an accurate estimate of the value of a firm if A) the debt-equity ratio remains constant for the life of the firm. B) amount of debt remains constant for the life of the firm. C) free cash flows remain constant for the life of the firm. D) the firm's financial leverage changes significantly over the life of the firm
A
32) Which of the following is not an important piece of U.S. antitrust legislation? A) Garn-St. Germain Act B) Clayton Act C) Hart-Scott-Rodino Act D) Clayton Act and Hart-Scott-Rodino Act
A
42) If an acquisition is completed using a cash payment, then the acquisition is A) taxable. B) viewed as exchanging of shares and is not taxed. C) a tax-free transaction as no capital gains or losses are recognized. D) None of these options are correct.
A
47) A dissident group solicits votes in an attempt to replace existing management. This is called a A) proxy fight. B) shareholder derivative action. C) tender offer. D) management freeze-out
A
48) A convertible bond is selling for $993. It has 15 years to maturity, $1,000 face value, and pays 8 percent coupon interest payments annually. Similar straight bonds (nonconvertible) are priced to yield 8.5 percent. The conversion ratio is 20. The stock is currently selling for $45. Calculate the convertible bond's option value. A) $34.52 B) $93.00 C) $7.00 D) $58.48
A
As a provider of funds to a corporation, owning which of the following corporate securities will give you the strongest rights to cash flow? A) Short-term bank loan B) Preferred stock C) Common stock D) Long-term bond
A
Assume the following data: Sales = 3,200; Cost of goods sold = 1,600; Total assets = 1,600; Inventory = 200. Calculate the asset turnover ratio.
A
Different classes of stocks are usually issued in order to A) maintain ownership control, by holding the class of stock with greater voting rights. B) pay less dividends to different classes of stock. C) extract perquisites without the other class of stockholders knowing. D) maintain ownership control by holding the class of stock with greater voting rights and pay less dividends to different classes of stock.
A
If you own 1,000 shares of stock and you can cast 5,000 votes for a particular director, then the stock features A) cumulative voting. B) straight voting. C) majority voting. D) proxy voting.
A
Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk because A) the effects of risk are opposite on the two value components and tend to cancel each other out. B) if the firm is high risk, the option premium will be higher while the straight bond value is fixed. C) only risky companies issued these instruments. D) the equity value is dependent on current risks only, not the future risk at conversion
A
The APV method is most useful in analyzing A) large international projects. B) domestic projects. C) small projects. D) projects having the same risk as the firm.
A
The APV method should be used A) when the project's level of debt is known over the life of the project. B) when the project's target debt to value ratio is constant over the life of the project. C) when the project's debt financing is unknown over the life of the project. D) when the level of debt doesn't change over the life of the firm.
A
The Miles-Ezzell formula for the adjusted cost of capital assumes that A) the firm rebalances its debt ratio only once per year. B) the project cash flow is a perpetuity. C) the project's risk is a carbon copy of the firm's risk. D) MM's Proposition I corrected for taxes holds (i.e., T* = TC)
A
The written agreement between a corporation and the bondholder's representative is called the A) indenture. B) collateral maintenance agreement. C) prospectus. D) debenture
A
Which of the following bonds is secured by assets? A) A mortgage bond B) A floating rate bond C) A debenture D) An indenture
A
Which of the following is the most sensible reason for issuing convertibles? A) Convertibles are convenient and flexible—they're usually unsecured and subordinated, and cash requirements for debt service are relatively low. B) Interest rates on convertible issues are significantly less than on straight debt. C) Firms that need equity capital use convertibles as a roundabout way of issuing stock. D) Firms prefer to issue convertibles when their shares are undervalued.
A
A firm has $100 million in current liabilities, $200 million in long-term debt, $300 million in stockholders' equity, and total book assets of $600 million. There are 100 million shares outstanding with a share price of $16. Calculate the debt ratio for the firm. A) 11.1 percent B) 66.7 percent C) 50 percent D) 33 percent
A 200/(200 + 16*100)
Firms often calculate a project's break-even sales using accounting profit. However, break-even sales based on NPV is generally A) higher than the one calculated using accounting profit. B) lower than the one calculated using accounting profit. C) equal to the one calculated using accounting profit. D) not related to the one calculated using accounting profit
A Think -- smth could look right w/ accounting but then u do npv and realize that it is not actually profitable
Two major differences between a warrant and a call option are I) warrants are contracts outside of the firm while options are within the firm; II) warrants have long maturities while options are usually short maturities; III) warrant exercise dilutes the value of equity while options exercise usually does not A) II and III only B) I only C) II only D) III only
A You can issue warrants to common stockholders
The largest and best documented LBO of the 1980s was
KKR acquiring RJR Nabisco
40) The PEN Corporation with a book value of $20 million and a market value of $30 million has acquired the CNC Corporation with a book value of $6 million and a market value of $8 million at a price of $9 million. If the transaction is a purchase, then the total assets on the books of the new company will be A) $38 million. B) $39 million. C) $29 million. D) $26 million.
Purchase method: $20 + $8 + $1 = $29.
Firm A has proposed to acquire Firm B at a price of $20 per share for Firm B's stock. Calculate the postmerger P/E ratio, assuming that cash is used in the acquisition and the merger has no immediate effect on total firm income.
Answer: A Explanation: P = ($10,000 + $600 − ($20 × $40 − $10 × $40))/$100 = 102. EPS = ($500 + $300)/$100 = 8. P/E ratio = 102/8 = 12.75.
19) Consider the following data: FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million. Assume that free cash flow grows at a rate of 4 percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the firm. A) $953.33 million B) $801.12 million C) $716.25 million D) $736.02 million
Answer: B Explanation: Horizon value in year 3 = (55)(1.04)/(0.10 − 0.04) = $953.33 million PV = (7/1.10) + (45/1.10^2) + [(55 + 953.33)/(1.10^3)] = $801.12 million
Flotation costs are incorporated into the APV framework by A) adding them to the all-equity value of the project. B) subtracting them from the all-equity value of the project. C) incorporating them into the WACC. D) Flotation costs should not be included into APV
B
Long-term bonds that are unsecured obligations of a company are called A) indentures. B) debentures. C) mortgage bonds. D) bearer bonds
B
A corporate bond matures in one year. The bond promises a $50 coupon and principal of $1,000 at maturity. Suppose the bond has a 10 percent probability of default and payment under default is $400. If an investor buys the bond for $907.14, calculate the promised yield on the bond. A) 6.6 percent B) 15.75 percent C) 5 percent D) 8.58 percent
B 1050/907.14
41) The DOC Corporation with a book value of $20 million and a market value of $30 million has acquired the CIC Corporation with a book value of $6 million and a market value of $8 million at a price of $9 million. If the transaction is a purchase, will there be any goodwill, and if so, what is the amount of goodwill? A) No goodwill; 0 B) Yes, goodwill; 3 C) Yes, goodwill; 1 D) Goodwill cannot be calculated with the information given.
B Purchase method: Book value after merger = 29 million Total book value while separate entities = 26 million Goodwill = 29 − 26 = 3 million
26) Assume the following data: EBIT = 400; Tax = 100; Sales = 3,000; Total assets = 1,500. Calculate the ROA (return on assets). A) 10.0 percent B) 20.0 percent C) 7.5 percent D) 26.7 percent
B ROA = (400 − 100)/1,500 = 20%.
The 1-year bonds of Casino, Inc., have a 12 percent coupon rate and trade in the market at a yield of 14 percent. There is a 5 percent chance that Casino will default and pay nothing. What cost of debt should be used in Casino's WACC? A) 14 percent B) 8.3 percent C) 12 percent D) 9.1 percent
B WACC uses the expected return on debt rather than the promised return. This is (0.95 × 14%) + (0.05 × −100%) − 1 = 8.3%
10) The following are sensible motives for mergers EXCEPT A) economies of scale. B) complementary resources. C) diversification. D) eliminating inefficiencies
C
18) Assume the following data: Current assets = 500; Current liabilities = 250; Inventory = 200; Account receivables = 200. Calculate the quick ratio. A) 1.0 B) 2.0 C) 1.2 D) 0.4
C
19) The following are advantages of spin-offs: I) They widen investor choice by allowing them to invest in just one part of the business. II) They can improve incentives for managers. III) By spinning off businesses with "poor fit," parent firms can concentrate on their core businesses. IV) They relieve investors of the worry that funds will be siphoned off from one business to support unprofitable capital investments in another. A) I and II only B) I, II, and III only C) I, II, III, and IV D) III and IV only
C
38) Following an acquisition, the acquiring firm's balance sheet shows an asset labeled "goodwill." What form of merger accounting was used? A) Consolidation B) Aggregation C) Purchase D) None of these options are correct
C
4) The difference between total assets of a firm and its total liabilities is called A) net working capital. B) net current assets. C) net worth. D) net liabilities
C
48) A modification of the corporate charter that requires 80 percent shareholder approval for a takeover is called a(n) A) repurchase standstill provision. B) exclusionary self-tender. C) supermajority amendment. D) tender offer
C
49) Which of the following statements about convertible bonds is true? A) A convertible bond cannot have a sinking fund. B) A callable bond cannot have a convertible feature. C) A convertible bond can also have a call feature. D) A convertible bond must have a sinking fund.
C
6) Merging in order to lower financing costs is likely to fail for the following reason: A) Costs of issuing larger amounts of debt increase. B) Tax shields decrease for larger companies. C) Any gain from lowering the required interest rate is offset by increased guarantees on the debt. D) It is difficult for bondholders to calculate the postmerger debt outstanding
C
T/F: ) U.S. firms, in general, have been repurchasing shares and thus net equity issues have been negative.
True
T/F: LBOs are typically financed with junk bond
True
T/F: LBOs often occur because managers are not maximizing shareholder value.
True
A project has the following cash flows: C0 = −100,000; C1 = 50,000; C2 = 150,000; C3 = 100,000. If the discount rate changes from 12 percent to 15 percent, what is the CHANGE in the NPV of the project (approximately)? A) 12,750 increase B) 12,750 decrease C) 14,240 increase D) 14,240 decrease
b
Exploitation of minority shareholders by majority shareholders is called A) a reverse stock split. B) tunneling. C) financial engineering. D) proxy fighting
b
The premium paid by investors to gain voting control, among the countries mentioned, is the highest in A) the United States. B) Mexico. C) Italy. D) None of these options
b
AT&T and Time Warner is an example of a A) cross-border merger. B) horizontal merger. C) conglomerate merger. D) vertical merger.
d
In order to calculate the tax shields provided by debt, the tax rate used is the
marginal corporate tax rate.
The Modigliani-Miller (MM) formula for the after-tax discount rate, for the case of fixed perpetual debt, is given by
rMM = r(1 − TCD/V).
7) Firm A plans to acquire Firm B by making a cash offer of $27 a share for all 100,000 shares of B. Cost savings with a present value of $800,000. Firm B's stock price increased from $20 to $24 per share. Firm A thus estimates Firm B's stand-alone price at $24. However, the CFO suggests a re-evaluation of the offer, pointing out that the true stand-alone value of Firm B may be $20 per share, not $24 per share. If the stand-alone value is $20 per share, will the merger still generate positive NPV for Firm A? A) No. The cost to acquire Firm B will exceed the postmerger gain of $800,000. B) No. Firm A will break even, since the costs are $400,000 more than expected. C) Yes. Firm A will still make a gain, although Firm B captures more of the economic gain than expected. D) Yes. Since the market is efficient, the true stand-alone value of Firm B is $24 per share
Answer: C Explanation: Firm A is trading $2.7 million [27 × 100,000] in exchange for a (potential) standalone value of $2 million [20 × 100,000]. Cost = Cash paid − PVB; 2.7 − 2 = 700K. This still leaves an NPV of $100K [800K − 700K] on the transaction, even with the pessimistic standalone value of $20.
24) The following data on a merger are given: Firm A Price per share $ 100 Total earnings $ 500 Shares outstanding 100 Total value $ 10,000 Firm B Price per share $ 10 Total earnings $ 300 Shares outstanding 40 Total value $ 400 Firm AB Total value $ 10,000 $ 400 $ 11,000 Firm A has proposed to acquire Firm B at a price of $20 per share for Firm B's stock. What will be the postmerger price per share for Firm A's stock if Firm A pays in cash? A) $108 B) $110 C) $102 D) $114
Answer: C Explanation: P = ($10,000 + $600 − ($20 × $40 − $10 × $40))/$100 = $102
11) Project M requires an initial investment of $25 million. The project is expected to generate $2.25 million in after-tax cash flow each year forever. Calculate the IRR for the project. A) 10 percent B) 9 percent C) 8 percent D) 7 percent
B
13) The main characteristic(s) of leveraged restructurings is (are) A) high debt. B) high debt and management incentives. C) high debt and private ownership. D) high debt, management incentives, and private ownership.
B
17) Spin-offs are not taxed if the shareholders of the parent company are given at least A) 90 percent of the shares in the new company. B) 80 percent of the shares in the new company. C) 70 percent of the shares in the new company. D) 60 percent of the shares in the new company.
B
27) Most privatizations resemble A) spin-offs. B) carve-outs. C) LBOs. D) both spin-offs and carve-outs
B
3) If a firm's management leads a leveraged buyout transaction, then the transaction is called a(n) A) IPO. B) MBO. C) MACRS. D) SEO.
B
31) Financial practitioners usually include short-term debt in WACC calculations if I) short-term debt is at least 10% of total liabilities; II) short-term debt is at least 10% of the total assets; III) net working capital is negative; IV) net working capital is positive A) I and IV only B) I and III only C) II and IV only D) II and III only
B
33) Antitrust law can be enforced by the U.S. federal government by I) a civil suit brought by the Justice Department; II) proceedings initiated by the Federal Trade Commission (FTC); III) proceedings initiated by the Securities and Exchange Commission (SEC) A) I only B) I and II only C) I, II, and III D) II only
B
34) The following statements are true of private-equity partnership agreements: I) The partnership agreement has a limited term, typically 10 years or less. II) The general partners get a management fee plus carried interest in 20% of any profits earned by the partnership. III) The limited partners get paid off first, but they get only 80% of any further returns. I V) The general partners can reinvest the limited partners' money. A) I and II only B) I, II, and III only C) I, II, III, and IV D) II and III only
B
36) What role do hedge funds take when they speculate on merger activity by buying stock of firms that are "in play"? A) Speculation causes an increased chance of antitrust lawsuits. B) Hedge funds specialize in taking on the risk that the deal will fall through and allow riskaverse investors to cash out. C) Hedge funds help reduce the cost of the merger to an acquirer. D) Hedge funds enable international mergers.
B
44) The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of stock. Then the conversion ratio A) is 40. B) is 25. C) is 100. D) depends on the current market price of the bond.
B
8) Which of the following actions by an acquiring firm signals its belief that postmerger gains will be substantially larger than expected? A) The acquiring firm makes a stock offer, since its stock value is priced lower than it will be postmerger. B) The acquiring firm makes a cash offer, since this allows the acquirer to solely benefit from gains not yet reflected in the market. C) The acquiring firm attempts to gain majority ownership, but not complete ownership. D) The acquiring firm makes an offer with the condition that management must be replaced
B
What is a Yankee Bond
Sold in the US by a foreign firm
