FUNDAMENTALS OF CORPORATE
FINANCE - COMPREHENSIVE FINAL
EXAM QUESTIONS AND CORRECT
ANSWERS LATEST UPDATE THIS YEAR
1. A firm is considering a project with a positive NPV. If the project’s risk is higher than the
firm’s average risk, but the firm uses its current WACC to evaluate the project, which of the
following is most likely?
A. The firm will correctly accept the project.
B. The project’s equity beta will be equal to the firm’s asset beta.
C. The project’s IRR will be lower than the WACC.
D. The firm might accept the project even if its true NPV is negative.
Answer: D
Conceptual Explanation: Using a WACC that is too low for a high-risk project
underestimates the required return, leading to an inflated NPV that may result in accepting
a value-destroying project.
2. According to the Modigliani-Miller Proposition II with corporate taxes, as a firm increases
its leverage, what happens to the cost of equity?
A. It remains constant because of the tax shield.
,B. It decreases because debt is cheaper than equity.
C. It increases, but at a slower rate than in a world without taxes.
D. It increases linearly with the debt-to-equity ratio.
Answer: C
Conceptual Explanation: While leverage increases the risk and cost of equity, the interest
tax shield reduces the effective increase in risk compared to the no-tax scenario.
3. Which of the following best describes the ‘Agency Cost of Debt’ known as the
underinvestment problem?
A. Shareholders refusing to fund positive NPV projects because the benefits accrue to
bondholders.
B. Managers choosing to waste cash on perks instead of paying dividends.
C. The firm taking on high-risk projects to transfer wealth from bondholders.
D. The increase in auditing costs required to satisfy lenders.
Answer: A
Conceptual Explanation: The underinvestment problem (debt overhang) occurs when a
firm is in financial distress and shareholders bypass positive NPV projects because the
value created primarily secures existing debt.
, 4. If the Yield to Maturity (YTM) of a bond is higher than its coupon rate, the bond must be
trading at:
A. Its intrinsic value only if the market is efficient.
B. Par value.
C. A premium.
D. A discount.
Answer: D
Conceptual Explanation: When the market’s required return (YTM) exceeds the coupon
rate, the bond price must drop below par value to provide the additional return.
5. In the context of the Capital Asset Pricing Model (CAPM), what does a ‘beta of zero’ imply
for an asset?
A. The asset has no total risk.
B. The asset is guaranteed to have a zero return.
C. The asset’s price is not affected by any economic factors.
D. The asset has an expected return equal to the risk-free rate.
Answer: D
Conceptual Explanation: A beta of zero means the asset has no systematic risk. According
to CAPM, E[Ri] = Rf + Beta(Rm - Rf). If Beta is zero, the expected return is the risk-free rate.
FINANCE - COMPREHENSIVE FINAL
EXAM QUESTIONS AND CORRECT
ANSWERS LATEST UPDATE THIS YEAR
1. A firm is considering a project with a positive NPV. If the project’s risk is higher than the
firm’s average risk, but the firm uses its current WACC to evaluate the project, which of the
following is most likely?
A. The firm will correctly accept the project.
B. The project’s equity beta will be equal to the firm’s asset beta.
C. The project’s IRR will be lower than the WACC.
D. The firm might accept the project even if its true NPV is negative.
Answer: D
Conceptual Explanation: Using a WACC that is too low for a high-risk project
underestimates the required return, leading to an inflated NPV that may result in accepting
a value-destroying project.
2. According to the Modigliani-Miller Proposition II with corporate taxes, as a firm increases
its leverage, what happens to the cost of equity?
A. It remains constant because of the tax shield.
,B. It decreases because debt is cheaper than equity.
C. It increases, but at a slower rate than in a world without taxes.
D. It increases linearly with the debt-to-equity ratio.
Answer: C
Conceptual Explanation: While leverage increases the risk and cost of equity, the interest
tax shield reduces the effective increase in risk compared to the no-tax scenario.
3. Which of the following best describes the ‘Agency Cost of Debt’ known as the
underinvestment problem?
A. Shareholders refusing to fund positive NPV projects because the benefits accrue to
bondholders.
B. Managers choosing to waste cash on perks instead of paying dividends.
C. The firm taking on high-risk projects to transfer wealth from bondholders.
D. The increase in auditing costs required to satisfy lenders.
Answer: A
Conceptual Explanation: The underinvestment problem (debt overhang) occurs when a
firm is in financial distress and shareholders bypass positive NPV projects because the
value created primarily secures existing debt.
, 4. If the Yield to Maturity (YTM) of a bond is higher than its coupon rate, the bond must be
trading at:
A. Its intrinsic value only if the market is efficient.
B. Par value.
C. A premium.
D. A discount.
Answer: D
Conceptual Explanation: When the market’s required return (YTM) exceeds the coupon
rate, the bond price must drop below par value to provide the additional return.
5. In the context of the Capital Asset Pricing Model (CAPM), what does a ‘beta of zero’ imply
for an asset?
A. The asset has no total risk.
B. The asset is guaranteed to have a zero return.
C. The asset’s price is not affected by any economic factors.
D. The asset has an expected return equal to the risk-free rate.
Answer: D
Conceptual Explanation: A beta of zero means the asset has no systematic risk. According
to CAPM, E[Ri] = Rf + Beta(Rm - Rf). If Beta is zero, the expected return is the risk-free rate.
