ADVANCED FUNDAMENTALS OF
CORPORATE FINANCE EXAM
QUESTIONS AND CORRECT ANSWERS
LATEST UPDATE THIS YEAR
1. Which of the following best describes the agency problem in a corporation?
A. The competition between different departments for capital budget allocation.
B. The disagreement between the board of directors and the federal regulators.
C. The conflict of interest between the firm’s managers and its shareholders.
D. The struggle between debt holders and tax authorities regarding interest shields.
Answer: C
Conceptual Explanation: The agency problem arises when managers (agents) act in their
own interest rather than maximizing shareholder (principal) wealth.
2. An increase in which of the following will decrease the present value of a future cash flow,
all else being equal?
A. The amount of the future cash flow.
B. The discounting frequency within a year.
C. The credit rating of the issuer.
D. The expected growth rate of the cash flow.
,Answer: B
Conceptual Explanation: Increasing the discounting frequency increases the effective
discount rate, which reduces the present value of a future sum.
3. Using the DuPont identity, if a firm increases its debt-to-equity ratio while keeping its
profit margin and total asset turnover constant, what happens to the ROE?
A. ROE decreases because interest expenses rise.
B. ROE remains unchanged because operations are constant.
C. ROE increases due to a higher equity multiplier.
D. ROE decreases because the total asset base expands.
Answer: C
Conceptual Explanation: The DuPont identity is ROE = Profit Margin * Asset Turnover *
Equity Multiplier. Higher debt increases the equity multiplier, raising ROE.
4. Which yield curve theory suggests that long-term rates are a function of expected future
short-term rates plus a risk premium?
A. Liquidity Preference Theory
B. Pure Expectations Theory
C. Market Segmentation Theory
D. Preferred Habitat Theory
Answer: A
, Conceptual Explanation: Liquidity Preference Theory posits that investors demand a
premium for the higher risk/lower liquidity of long-term bonds compared to short-term
ones.
5. If the Net Present Value (NPV) of a project is zero, which of the following must be true?
A. The Profitability Index (PI) is zero.
B. The accounting rate of return is also zero.
C. The project has a payback period of exactly one year.
D. The project’s Internal Rate of Return (IRR) equals the required return.
Answer: D
Conceptual Explanation: The IRR is the discount rate that makes NPV equal to zero. If
NPV is zero at the cost of capital, the IRR must equal that cost of capital.
6. According to the Pecking Order Theory, how do firms prefer to finance their projects?
A. New Equity, then Debt, then Internal Funds.
B. Debt, then Internal Funds, then New Equity.
C. Internal Funds, then Debt, then New Equity.
D. Internal Funds, then New Equity, then Debt.
Answer: C
Conceptual Explanation: Firms prefer internal financing first to avoid information
asymmetry costs, followed by debt, and equity as a last resort.
CORPORATE FINANCE EXAM
QUESTIONS AND CORRECT ANSWERS
LATEST UPDATE THIS YEAR
1. Which of the following best describes the agency problem in a corporation?
A. The competition between different departments for capital budget allocation.
B. The disagreement between the board of directors and the federal regulators.
C. The conflict of interest between the firm’s managers and its shareholders.
D. The struggle between debt holders and tax authorities regarding interest shields.
Answer: C
Conceptual Explanation: The agency problem arises when managers (agents) act in their
own interest rather than maximizing shareholder (principal) wealth.
2. An increase in which of the following will decrease the present value of a future cash flow,
all else being equal?
A. The amount of the future cash flow.
B. The discounting frequency within a year.
C. The credit rating of the issuer.
D. The expected growth rate of the cash flow.
,Answer: B
Conceptual Explanation: Increasing the discounting frequency increases the effective
discount rate, which reduces the present value of a future sum.
3. Using the DuPont identity, if a firm increases its debt-to-equity ratio while keeping its
profit margin and total asset turnover constant, what happens to the ROE?
A. ROE decreases because interest expenses rise.
B. ROE remains unchanged because operations are constant.
C. ROE increases due to a higher equity multiplier.
D. ROE decreases because the total asset base expands.
Answer: C
Conceptual Explanation: The DuPont identity is ROE = Profit Margin * Asset Turnover *
Equity Multiplier. Higher debt increases the equity multiplier, raising ROE.
4. Which yield curve theory suggests that long-term rates are a function of expected future
short-term rates plus a risk premium?
A. Liquidity Preference Theory
B. Pure Expectations Theory
C. Market Segmentation Theory
D. Preferred Habitat Theory
Answer: A
, Conceptual Explanation: Liquidity Preference Theory posits that investors demand a
premium for the higher risk/lower liquidity of long-term bonds compared to short-term
ones.
5. If the Net Present Value (NPV) of a project is zero, which of the following must be true?
A. The Profitability Index (PI) is zero.
B. The accounting rate of return is also zero.
C. The project has a payback period of exactly one year.
D. The project’s Internal Rate of Return (IRR) equals the required return.
Answer: D
Conceptual Explanation: The IRR is the discount rate that makes NPV equal to zero. If
NPV is zero at the cost of capital, the IRR must equal that cost of capital.
6. According to the Pecking Order Theory, how do firms prefer to finance their projects?
A. New Equity, then Debt, then Internal Funds.
B. Debt, then Internal Funds, then New Equity.
C. Internal Funds, then Debt, then New Equity.
D. Internal Funds, then New Equity, then Debt.
Answer: C
Conceptual Explanation: Firms prefer internal financing first to avoid information
asymmetry costs, followed by debt, and equity as a last resort.
