FUNDAMENTALS OF CORPORATE
FINANCE (4TH CANADIAN EDITION) -
ADVANCED QUESTIONS AND CORRECT
ANSWERS LATEST UPDATE THIS YEAR
1. A corporation is considering a new project with an initial investment of $500,000. The
project falls under a CCA class with a rate of 30%. If the corporate tax rate is 25% and the
discount rate is 10%, what is the present value of the CCA tax shield, assuming the half-year
rule applies?
A. $90,909
B. $78,450
C. $102,273
D. $85,227
Answer: D
Conceptual Explanation: The formula for the PV of the CCA tax shield including the half-
year rule is [CdT / (d + r)] * [(1 + 0.5r) / (1 + r)]. Plugging in: [500000 * 0.30 * 0.25 / (0.30
+ 0.10)] * [1..10] = 93750 * 0.9545 = $85,227.27.
2. According to the Modigliani-Miller Proposition II with corporate taxes, how does the cost
of equity (Re) behave as the debt-to-equity ratio increases?
A. It remains constant regardless of leverage.
,B. It decreases because debt is cheaper than equity.
C. It increases linearly with the debt-to-equity ratio.
D. It increases at a decreasing rate due to the tax shield.
Answer: C
Conceptual Explanation: MM Prop II states that the cost of equity increases as the firm
takes on more debt because the risk to equity holders rises. Specifically, Re = Ru +
(D/E)(Ru - Rd)(1 - Tc).
3. In the context of the DuPont Identity, if a firm increases its financial leverage while keeping
its net profit margin and total asset turnover constant, what will be the impact on the Return
on Equity (ROE)?
A. ROE will remain unchanged.
B. ROE will decrease.
C. ROE will increase.
D. ROE will become volatile but average zero.
Answer: C
Conceptual Explanation: The DuPont Identity is ROE = Profit Margin * Asset Turnover *
Equity Multiplier. Since the Equity Multiplier represents leverage (Assets/Equity),
increasing leverage increases the multiplier, thus increasing ROE.
, 4. An investor is looking at a bond with a 7% coupon rate, paid semi-annually, with 10 years
to maturity. If the market yield (YTM) is 8%, the bond is currently trading at:
A. Par value
B. A premium
C. A discount
D. Its face value
Answer: C
Conceptual Explanation: When the YTM is higher than the coupon rate, the bond must
sell at a discount to provide the investor with the higher market return.
5. Which of the following scenarios best describes an ‘Agency Conflict’ of the first type?
A. Conflicts between common shareholders and preferred shareholders.
B. Conflicts between the firm’s creditors and its customers.
C. Conflicts between the managers of a firm and its shareholders.
D. Conflicts between minority and majority shareholders.
Answer: C
Conceptual Explanation: Type I agency conflict refers to the classic principal-agent
problem where managers (agents) may act in their own interest rather than the interest of
the shareholders (principals).
FINANCE (4TH CANADIAN EDITION) -
ADVANCED QUESTIONS AND CORRECT
ANSWERS LATEST UPDATE THIS YEAR
1. A corporation is considering a new project with an initial investment of $500,000. The
project falls under a CCA class with a rate of 30%. If the corporate tax rate is 25% and the
discount rate is 10%, what is the present value of the CCA tax shield, assuming the half-year
rule applies?
A. $90,909
B. $78,450
C. $102,273
D. $85,227
Answer: D
Conceptual Explanation: The formula for the PV of the CCA tax shield including the half-
year rule is [CdT / (d + r)] * [(1 + 0.5r) / (1 + r)]. Plugging in: [500000 * 0.30 * 0.25 / (0.30
+ 0.10)] * [1..10] = 93750 * 0.9545 = $85,227.27.
2. According to the Modigliani-Miller Proposition II with corporate taxes, how does the cost
of equity (Re) behave as the debt-to-equity ratio increases?
A. It remains constant regardless of leverage.
,B. It decreases because debt is cheaper than equity.
C. It increases linearly with the debt-to-equity ratio.
D. It increases at a decreasing rate due to the tax shield.
Answer: C
Conceptual Explanation: MM Prop II states that the cost of equity increases as the firm
takes on more debt because the risk to equity holders rises. Specifically, Re = Ru +
(D/E)(Ru - Rd)(1 - Tc).
3. In the context of the DuPont Identity, if a firm increases its financial leverage while keeping
its net profit margin and total asset turnover constant, what will be the impact on the Return
on Equity (ROE)?
A. ROE will remain unchanged.
B. ROE will decrease.
C. ROE will increase.
D. ROE will become volatile but average zero.
Answer: C
Conceptual Explanation: The DuPont Identity is ROE = Profit Margin * Asset Turnover *
Equity Multiplier. Since the Equity Multiplier represents leverage (Assets/Equity),
increasing leverage increases the multiplier, thus increasing ROE.
, 4. An investor is looking at a bond with a 7% coupon rate, paid semi-annually, with 10 years
to maturity. If the market yield (YTM) is 8%, the bond is currently trading at:
A. Par value
B. A premium
C. A discount
D. Its face value
Answer: C
Conceptual Explanation: When the YTM is higher than the coupon rate, the bond must
sell at a discount to provide the investor with the higher market return.
5. Which of the following scenarios best describes an ‘Agency Conflict’ of the first type?
A. Conflicts between common shareholders and preferred shareholders.
B. Conflicts between the firm’s creditors and its customers.
C. Conflicts between the managers of a firm and its shareholders.
D. Conflicts between minority and majority shareholders.
Answer: C
Conceptual Explanation: Type I agency conflict refers to the classic principal-agent
problem where managers (agents) may act in their own interest rather than the interest of
the shareholders (principals).
