FUNDAMENTALS OF CORPORATE
FINANCE (CANADIAN 4E) - ADVANCED
COMPREHENSIVE EXAM QUESTIONS
AND CORRECT ANSWERS LATEST
UPDATE THIS YEAR
1. A corporation is considering a project with a 5-year life. The initial investment is $500,000,
and it will be depreciated straight-line to zero over 5 years. If the project generates $150,000
in annual pre-tax operating income and the corporate tax rate is 27%, what is the annual
operating cash flow (OCF)?
A. $139,500
B. $109,500
C. $136,500
D. $123,000
Answer: A
Conceptual Explanation: OCF = (Sales - Costs) * (1 - T) + (Depreciation * T). Sales - Costs =
$150,000. Depreciation = $500, = $100,000. OCF = ($150,000 * (1 - 0.27)) +
($100,000 * 0.27) = $109,500 + $27,000 = $136,500. Wait, OCF = EBIT + Depreciation -
Taxes. EBIT = 150k - 100k = 50k. Tax = 50k * 0.27 = 13.5k. OCF = 50k + 100k - 13.5k =
136.5k.
,2. According to the Modigliani-Miller Proposition II with corporate taxes, what happens to
the cost of equity 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 at a decreasing rate due to the tax shield.
D. It increases linearly to compensate for the higher financial risk.
Answer: D
Conceptual Explanation: MM Proposition II states that the cost of equity increases as the
firm’s leverage increases because the risk to equity holders rises, even when considering
the tax advantage of debt.
3. A firm has a P/E ratio of 15, a net profit margin of 8%, and a total asset turnover of 1.5. If
the equity multiplier is 2.0, what is the firm’s Price-to-Book (P/B) ratio?
A. 3.6
B. 1.8
C. 2.4
D. 4.2
Answer: A
Conceptual Explanation: ROE = Margin * Turnover * Multiplier = 0.08 * 1.5 * 2.0 = 0.24.
P/B = P/E * ROE = 15 * 0.24 = 3.6.
, 4. In the context of the Canadian tax system, which of the following best describes the
‘dividend gross-up and credit’ mechanism?
A. It allows corporations to deduct dividend payments from taxable income.
B. It applies only to foreign dividends received by Canadian residents.
C. It is designed to eliminate the double taxation of corporate income at the individual level.
D. It ensures that capital gains are taxed at the same rate as interest income.
Answer: C
Conceptual Explanation: The dividend gross-up and tax credit system in Canada is
intended to integrate corporate and personal taxes so that income earned through a
corporation is taxed at roughly the same rate as income earned directly.
5. An investor holds a portfolio with a beta of 1.2. The risk-free rate is 3% and the expected
market risk premium is 6%. If the investor adds a risk-free asset to the portfolio such that the
new beta is 0.9, what is the new expected return?
A. 9.0%
B. 10.2%
C. 7.5%
D. 8.4%
Answer: D
FINANCE (CANADIAN 4E) - ADVANCED
COMPREHENSIVE EXAM QUESTIONS
AND CORRECT ANSWERS LATEST
UPDATE THIS YEAR
1. A corporation is considering a project with a 5-year life. The initial investment is $500,000,
and it will be depreciated straight-line to zero over 5 years. If the project generates $150,000
in annual pre-tax operating income and the corporate tax rate is 27%, what is the annual
operating cash flow (OCF)?
A. $139,500
B. $109,500
C. $136,500
D. $123,000
Answer: A
Conceptual Explanation: OCF = (Sales - Costs) * (1 - T) + (Depreciation * T). Sales - Costs =
$150,000. Depreciation = $500, = $100,000. OCF = ($150,000 * (1 - 0.27)) +
($100,000 * 0.27) = $109,500 + $27,000 = $136,500. Wait, OCF = EBIT + Depreciation -
Taxes. EBIT = 150k - 100k = 50k. Tax = 50k * 0.27 = 13.5k. OCF = 50k + 100k - 13.5k =
136.5k.
,2. According to the Modigliani-Miller Proposition II with corporate taxes, what happens to
the cost of equity 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 at a decreasing rate due to the tax shield.
D. It increases linearly to compensate for the higher financial risk.
Answer: D
Conceptual Explanation: MM Proposition II states that the cost of equity increases as the
firm’s leverage increases because the risk to equity holders rises, even when considering
the tax advantage of debt.
3. A firm has a P/E ratio of 15, a net profit margin of 8%, and a total asset turnover of 1.5. If
the equity multiplier is 2.0, what is the firm’s Price-to-Book (P/B) ratio?
A. 3.6
B. 1.8
C. 2.4
D. 4.2
Answer: A
Conceptual Explanation: ROE = Margin * Turnover * Multiplier = 0.08 * 1.5 * 2.0 = 0.24.
P/B = P/E * ROE = 15 * 0.24 = 3.6.
, 4. In the context of the Canadian tax system, which of the following best describes the
‘dividend gross-up and credit’ mechanism?
A. It allows corporations to deduct dividend payments from taxable income.
B. It applies only to foreign dividends received by Canadian residents.
C. It is designed to eliminate the double taxation of corporate income at the individual level.
D. It ensures that capital gains are taxed at the same rate as interest income.
Answer: C
Conceptual Explanation: The dividend gross-up and tax credit system in Canada is
intended to integrate corporate and personal taxes so that income earned through a
corporation is taxed at roughly the same rate as income earned directly.
5. An investor holds a portfolio with a beta of 1.2. The risk-free rate is 3% and the expected
market risk premium is 6%. If the investor adds a risk-free asset to the portfolio such that the
new beta is 0.9, what is the new expected return?
A. 9.0%
B. 10.2%
C. 7.5%
D. 8.4%
Answer: D
