2024/2025 FIN3701 Corporate Finance
Exam Bundle | Latest Exam Questions
with Verified Solutions
1. Introduction
This comprehensive exam bundle focuses on key corporate finance topics, including financial
decisions, business organization forms, liquidity, cash flows, risk, return, capital budgeting, cost
of capital, capital structure, and more. Questions are drawn from reliable sources and simplified
for clarity. Verified solutions are provided for each question to aid in preparation.
2. Basic Corporate Finance Concepts
These questions cover foundational topics in corporate finance.
Q1: What are three types of financial management decisions? Give an example for each.
A1: Capital budgeting (deciding whether to expand a manufacturing plant), capital struc-
ture (deciding whether to issue new equity and use the proceeds to retire outstanding debt),
and working capital management (modifying the firm’s credit collection policy with its
customers).
Q2: What are four primary disadvantages of the sole proprietorship and partnership forms of
business organization? What benefits do they have compared to the corporate form?
A2: Disadvantages: unlimited liability, limited life, difficulty in transferring ownership,
difficulty in raising capital funds. Benefits: simpler, less regulation, owners are also man-
agers, sometimes personal tax rates are better than corporate tax rates.
Q3: What is the primary disadvantage of the corporate form of organization? Name at least
two advantages.
A3: The primary disadvantage is double taxation on distributed earnings and dividends.
Advantages include limited liability, ease of transferability, ability to raise capital, and
unlimited life.
Q4: Why might small firms choose to ”go dark” and delist their stock after the Sarbanes-Oxley
Act? What are the costs?
A4: To avoid compliance costs, which can be several million dollars and a large part of
profits. Costs include less access to capital, as the firm can no longer raise money in
public markets, and higher costs in private markets like bank loans.
Q5: What does liquidity measure? Explain the trade-off between high and low liquidity.
A5: Liquidity measures how quickly an asset can be converted to cash without significant
1
, loss. High liquidity provides safety for short-term debts but has opportunity costs, as cash
could earn higher returns elsewhere. Firms balance these needs.
Q6: Why might revenue and cost figures on an income statement not represent actual cash
flows?
A6: Revenues and costs are recorded when earned or incurred, not when cash is received
or paid, due to recognition and matching principles.
Q7: Why does accounting use historical cost rather than market value on balance sheets?
A7: Historical costs are objective and precise, while market values are estimates that vary
by analyst, trading relevance for objectivity.
Q8: Name two items in net income not in operating cash flow. Explain why each is excluded.
A8: Depreciation (noncash adjustment for asset values) and interest expense (financing
cost, not operating).
Q9: Can liabilities exceed assets in market values? Why or why not?
A9: No, market values cannot be negative due to bankruptcy laws; net worth cannot be
negative.
Q10: Is negative cash flow from assets always bad?
A10: Not necessarily; it could indicate rapid expansion with large capital outlays.
Q11: Which best defines the variance of an investment’s annual returns?
A11: The average squared difference between actual returns and the arithmetic average
return.
Q12: What does standard deviation measure?
A12: Volatility.
Q13: What is defined by its mean and standard deviation?
A13: Normal distribution.
Q14: What is the average compound return over multiple years called?
A14: Geometric average return.
Q15: The real rate of return on a stock is approximately the nominal rate minus what?
A15: Minus the inflation rate.
Q16: Which statement is correct about returns?
A16: Greater volatility means greater risk premium.
Q17: If large-company stock return variability increases long-term, what happens?
A17: Risk premium increases, equity cost rises.
Q18: Historical arithmetic average tends to overestimate long-term returns, while geometric
does what for short-term?
A18: Underestimates short-term returns.
Q19: Why might a stock price not react to new information?
A19: Information already anticipated or not material.
Q20: What measures systematic risk relative to average risky asset?
A20: Beta.
2
Exam Bundle | Latest Exam Questions
with Verified Solutions
1. Introduction
This comprehensive exam bundle focuses on key corporate finance topics, including financial
decisions, business organization forms, liquidity, cash flows, risk, return, capital budgeting, cost
of capital, capital structure, and more. Questions are drawn from reliable sources and simplified
for clarity. Verified solutions are provided for each question to aid in preparation.
2. Basic Corporate Finance Concepts
These questions cover foundational topics in corporate finance.
Q1: What are three types of financial management decisions? Give an example for each.
A1: Capital budgeting (deciding whether to expand a manufacturing plant), capital struc-
ture (deciding whether to issue new equity and use the proceeds to retire outstanding debt),
and working capital management (modifying the firm’s credit collection policy with its
customers).
Q2: What are four primary disadvantages of the sole proprietorship and partnership forms of
business organization? What benefits do they have compared to the corporate form?
A2: Disadvantages: unlimited liability, limited life, difficulty in transferring ownership,
difficulty in raising capital funds. Benefits: simpler, less regulation, owners are also man-
agers, sometimes personal tax rates are better than corporate tax rates.
Q3: What is the primary disadvantage of the corporate form of organization? Name at least
two advantages.
A3: The primary disadvantage is double taxation on distributed earnings and dividends.
Advantages include limited liability, ease of transferability, ability to raise capital, and
unlimited life.
Q4: Why might small firms choose to ”go dark” and delist their stock after the Sarbanes-Oxley
Act? What are the costs?
A4: To avoid compliance costs, which can be several million dollars and a large part of
profits. Costs include less access to capital, as the firm can no longer raise money in
public markets, and higher costs in private markets like bank loans.
Q5: What does liquidity measure? Explain the trade-off between high and low liquidity.
A5: Liquidity measures how quickly an asset can be converted to cash without significant
1
, loss. High liquidity provides safety for short-term debts but has opportunity costs, as cash
could earn higher returns elsewhere. Firms balance these needs.
Q6: Why might revenue and cost figures on an income statement not represent actual cash
flows?
A6: Revenues and costs are recorded when earned or incurred, not when cash is received
or paid, due to recognition and matching principles.
Q7: Why does accounting use historical cost rather than market value on balance sheets?
A7: Historical costs are objective and precise, while market values are estimates that vary
by analyst, trading relevance for objectivity.
Q8: Name two items in net income not in operating cash flow. Explain why each is excluded.
A8: Depreciation (noncash adjustment for asset values) and interest expense (financing
cost, not operating).
Q9: Can liabilities exceed assets in market values? Why or why not?
A9: No, market values cannot be negative due to bankruptcy laws; net worth cannot be
negative.
Q10: Is negative cash flow from assets always bad?
A10: Not necessarily; it could indicate rapid expansion with large capital outlays.
Q11: Which best defines the variance of an investment’s annual returns?
A11: The average squared difference between actual returns and the arithmetic average
return.
Q12: What does standard deviation measure?
A12: Volatility.
Q13: What is defined by its mean and standard deviation?
A13: Normal distribution.
Q14: What is the average compound return over multiple years called?
A14: Geometric average return.
Q15: The real rate of return on a stock is approximately the nominal rate minus what?
A15: Minus the inflation rate.
Q16: Which statement is correct about returns?
A16: Greater volatility means greater risk premium.
Q17: If large-company stock return variability increases long-term, what happens?
A17: Risk premium increases, equity cost rises.
Q18: Historical arithmetic average tends to overestimate long-term returns, while geometric
does what for short-term?
A18: Underestimates short-term returns.
Q19: Why might a stock price not react to new information?
A19: Information already anticipated or not material.
Q20: What measures systematic risk relative to average risky asset?
A20: Beta.
2
