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FOUNDATIONS OF FINANCE 10TH EDITION — ORIGINAL
PRACTICE QUESTION BANK
QUESTIONS 1–200 AND DETAILED ANSWERS | ADVANCED
EXAM-STYLE PRACTICE | UPDATED 2026/2027
INTRODUCTION
Foundations of Finance, 10th Edition by Arthur J. Keown introduces the fundamental principles
used to analyze financial decisions, value securities and projects, manage risk, and evaluate the
performance of firms. The material is particularly relevant to students studying corporate
finance, investments, financial management, and related business disciplines. Success requires
more than memorizing formulas: students must be able to select appropriate valuation
techniques, interpret financial information, evaluate risk and return, and apply financial
principles to realistic business decisions.
This original practice bank is designed to provide challenging, application-level preparation
across the major areas of introductory finance. The questions emphasize quantitative reasoning,
financial interpretation, time-value-of-money analysis, capital budgeting, valuation, risk, capital
structure, working-capital management, and corporate financial decision-making. Each question
contains four alternatives with one best answer, followed by a detailed rationale explaining both
the correct choice and the weaknesses of the alternatives.
Use the questions as a diagnostic tool: first attempt each problem without consulting the
rationale, record your answers, and then review the explanations carefully. Reworking missed
quantitative problems is especially valuable because finance examinations frequently test
whether students can identify the correct method before performing the calculation.
CORE DOMAINS TESTED
1. Financial Management and the Financial Environment — Objectives of financial
management, agency relationships, financial markets, institutions, and the role of the
financial manager.
2. Financial Statements and Cash Flow — Interpretation of accounting statements,
operating cash flow, free cash flow, and financial ratios.
3. Time Value of Money — Present value, future value, annuities, perpetuities, uneven cash
flows, and effective interest rates.
4. Risk and Return — Expected returns, variance, standard deviation, diversification,
systematic risk, and required returns.
5. Bond Valuation — Bond pricing, yields, interest-rate sensitivity, premiums and
discounts, and term structure.
6. Stock Valuation — Dividend-discount models, growth assumptions, required returns, and
valuation implications.
7. Capital Budgeting — NPV, IRR, payback, profitability measures, incremental cash
flows, and project risk.
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8. Cost of Capital — Cost of debt, preferred stock, common equity, WACC, and financing
implications.
9. Capital Structure — Leverage, operating and financial risk, EBIT-EPS analysis, and
financing choices.
10. Dividend Policy — Dividend decisions, repurchases, payout ratios, and investor
implications.
11. Working Capital Management — Cash, receivables, inventory, payables, liquidity, and
short-term financing.
12. Financial Planning and Forecasting — Pro forma statements, external financing
requirements, sustainable growth, and financial planning.
13. International Finance — Exchange rates, multinational financial decisions, currency
exposure, and international valuation.
QUESTIONS 1-200
Q1: A manufacturing company reports rising net income for three consecutive years, yet its
operating cash flow has declined substantially. An analyst discovers that accounts receivable
have grown much faster than sales. Which explanation best accounts for the divergence between
accounting profit and operating cash flow?
A) Depreciation expense has increased, creating a larger cash outflow.
B) The company is recognizing sales before collecting the related cash, causing an increase
in working capital that reduces operating cash flow.
C) Higher accounts receivable automatically increase operating cash flow because they represent
future cash receipts.
D) Net income and operating cash flow must always increase by the same amount.
Rationale: B is correct because an increase in accounts receivable represents revenue
recognized but not yet collected in cash. Under the indirect cash-flow approach, an increase in
accounts receivable is subtracted from net income when calculating operating cash flow. A is
incorrect because depreciation is a noncash expense and, when it increases, it is added back
rather than treated as a cash outflow. C reverses the cash-flow effect of receivables growth. D is
incorrect because accrual accounting causes net income and cash flow to differ.
Q2: A firm's CFO is evaluating a proposed investment that is expected to increase annual sales
by $2 million and annual operating costs by $1.3 million. The project requires $400,000 of
additional working capital immediately, all of which is expected to be recovered at the end of the
project. Which item should be treated as an incremental cash-flow consequence of the working-
capital investment?
A) The initial working-capital investment should be ignored because it does not affect
accounting income.
B) The $400,000 initial working-capital investment is a cash outflow, while its later
recovery is a cash inflow.
C) The working-capital investment is an operating expense and should be deducted from EBIT
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every year.
D) Only the recovered working capital affects project cash flow.
Rationale: B is correct because an increase in net working capital requires an immediate cash
investment. Although it may not appear as an expense on the income statement, it ties up cash
and therefore affects project cash flows. Recovery at project termination releases that cash. A
and D ignore the cash-flow effect of the initial investment. C incorrectly treats a balance-sheet
investment as a recurring operating expense.
Q3: An investor can choose between two mutually exclusive projects. Project A has an IRR of
19% and an NPV of $80,000, while Project B has an IRR of 16% and an NPV of $125,000 at the
firm's 10% required return. Which project should normally be selected?
A) Project A because its IRR is higher.
B) Project B because it produces the greater positive NPV.
C) Project A because IRR is always superior to NPV.
D) Either project because both have positive NPVs.
Rationale: B is correct because NPV directly measures the increase in shareholder wealth
expected from undertaking a project, assuming the cash flows and discount rate are appropriate.
Project B creates $125,000 of value versus $80,000 for A. A is incorrect because a higher IRR
does not necessarily mean greater value, especially for mutually exclusive projects. C is false
because NPV is generally the preferred decision criterion for value maximization. D is incorrect
because mutually exclusive projects require choosing the one that creates greater value.
Q4: A firm is considering replacing an existing machine. The old machine has a current market
value of $70,000 but a book value of $40,000. The firm's tax rate is 25%. If the machine is sold
today, what is the after-tax cash flow from the sale?
A) $40,000
B) $62,500
C) $62,500
D) $70,000
Rationale: C is correct. The machine produces a taxable gain of $70,000 − $40,000 = $30,000.
The tax on the gain is $30,000 × 25% = $7,500. Therefore, the after-tax proceeds are $70,000 −
$7,500 = $62,500. A is merely the book value. B does not reflect the correct tax calculation. D
ignores the tax liability created by the gain.
Q5: An investor deposits $10,000 into an account earning 8% annually. Interest is compounded
quarterly. Approximately how much will the account contain after three years?
A) $12,400
B) $12,512
C) $12,683
D) $13,200
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Rationale: C is correct. With quarterly compounding, the periodic rate is 8%/4 = 2%, and there
are 3 × 4 = 12 periods. The future value is approximately $10,000(1.02)^12 = $12,683. A and B
underestimate the effect of quarterly compounding. D overstates the accumulated value.
Q6: A bond has a $1,000 face value, a 7% annual coupon rate, and 10 years remaining to
maturity. Market interest rates for bonds of comparable risk rise from 7% to 9%. What should
happen to the bond's market price?
A) It should rise above $1,000 because the bond still pays a fixed coupon.
B) It should remain exactly at $1,000 until maturity.
C) It should fall below $1,000 because its fixed coupon payments are less attractive relative
to newly issued bonds.
D) It should rise because higher market rates increase all future cash flows.
Rationale: C is correct because bond prices and market yields move inversely. Existing bonds
with a 7% coupon become less valuable when comparable securities offer 9%. The bond must
sell at a discount so that a buyer's total expected return is competitive with the market. A and D
incorrectly assume higher market rates increase the value of existing fixed payments. B is true
only if the market yield equals the coupon rate.
Q7: A company estimates that its required return on common equity is 12%, its after-tax cost of
debt is 5%, and its capital structure consists of 60% equity and 40% debt. What is its
approximate WACC?
A) 5.0%
B) 7.0%
C) 9.2%
D) 12.0%
Rationale: C is correct. WACC = (0.60 × 12%) + (0.40 × 5%) = 7.2% + 2.0% = 9.2%. A
represents only the after-tax debt cost. B does not correctly weight the components. D represents
only the equity cost and ignores debt financing.
Q8: A company has annual credit sales of $18 million and average accounts receivable of $3
million. Assuming a 365-day year, approximately how many days of sales are tied up in
receivables?
A) 30.4 days
B) 45.0 days
C) 60.8 days
D) 90.2 days
Rationale: C is correct. The receivables turnover ratio is $18 million/$3 million = 6 times.
Average collection period is approximately 365/6 = 60.8 days. A and B imply substantially faster
collection than the firm's actual turnover. D overstates the collection period.
FOUNDATIONS OF FINANCE 10TH EDITION — ORIGINAL
PRACTICE QUESTION BANK
QUESTIONS 1–200 AND DETAILED ANSWERS | ADVANCED
EXAM-STYLE PRACTICE | UPDATED 2026/2027
INTRODUCTION
Foundations of Finance, 10th Edition by Arthur J. Keown introduces the fundamental principles
used to analyze financial decisions, value securities and projects, manage risk, and evaluate the
performance of firms. The material is particularly relevant to students studying corporate
finance, investments, financial management, and related business disciplines. Success requires
more than memorizing formulas: students must be able to select appropriate valuation
techniques, interpret financial information, evaluate risk and return, and apply financial
principles to realistic business decisions.
This original practice bank is designed to provide challenging, application-level preparation
across the major areas of introductory finance. The questions emphasize quantitative reasoning,
financial interpretation, time-value-of-money analysis, capital budgeting, valuation, risk, capital
structure, working-capital management, and corporate financial decision-making. Each question
contains four alternatives with one best answer, followed by a detailed rationale explaining both
the correct choice and the weaknesses of the alternatives.
Use the questions as a diagnostic tool: first attempt each problem without consulting the
rationale, record your answers, and then review the explanations carefully. Reworking missed
quantitative problems is especially valuable because finance examinations frequently test
whether students can identify the correct method before performing the calculation.
CORE DOMAINS TESTED
1. Financial Management and the Financial Environment — Objectives of financial
management, agency relationships, financial markets, institutions, and the role of the
financial manager.
2. Financial Statements and Cash Flow — Interpretation of accounting statements,
operating cash flow, free cash flow, and financial ratios.
3. Time Value of Money — Present value, future value, annuities, perpetuities, uneven cash
flows, and effective interest rates.
4. Risk and Return — Expected returns, variance, standard deviation, diversification,
systematic risk, and required returns.
5. Bond Valuation — Bond pricing, yields, interest-rate sensitivity, premiums and
discounts, and term structure.
6. Stock Valuation — Dividend-discount models, growth assumptions, required returns, and
valuation implications.
7. Capital Budgeting — NPV, IRR, payback, profitability measures, incremental cash
flows, and project risk.
,2|Page
8. Cost of Capital — Cost of debt, preferred stock, common equity, WACC, and financing
implications.
9. Capital Structure — Leverage, operating and financial risk, EBIT-EPS analysis, and
financing choices.
10. Dividend Policy — Dividend decisions, repurchases, payout ratios, and investor
implications.
11. Working Capital Management — Cash, receivables, inventory, payables, liquidity, and
short-term financing.
12. Financial Planning and Forecasting — Pro forma statements, external financing
requirements, sustainable growth, and financial planning.
13. International Finance — Exchange rates, multinational financial decisions, currency
exposure, and international valuation.
QUESTIONS 1-200
Q1: A manufacturing company reports rising net income for three consecutive years, yet its
operating cash flow has declined substantially. An analyst discovers that accounts receivable
have grown much faster than sales. Which explanation best accounts for the divergence between
accounting profit and operating cash flow?
A) Depreciation expense has increased, creating a larger cash outflow.
B) The company is recognizing sales before collecting the related cash, causing an increase
in working capital that reduces operating cash flow.
C) Higher accounts receivable automatically increase operating cash flow because they represent
future cash receipts.
D) Net income and operating cash flow must always increase by the same amount.
Rationale: B is correct because an increase in accounts receivable represents revenue
recognized but not yet collected in cash. Under the indirect cash-flow approach, an increase in
accounts receivable is subtracted from net income when calculating operating cash flow. A is
incorrect because depreciation is a noncash expense and, when it increases, it is added back
rather than treated as a cash outflow. C reverses the cash-flow effect of receivables growth. D is
incorrect because accrual accounting causes net income and cash flow to differ.
Q2: A firm's CFO is evaluating a proposed investment that is expected to increase annual sales
by $2 million and annual operating costs by $1.3 million. The project requires $400,000 of
additional working capital immediately, all of which is expected to be recovered at the end of the
project. Which item should be treated as an incremental cash-flow consequence of the working-
capital investment?
A) The initial working-capital investment should be ignored because it does not affect
accounting income.
B) The $400,000 initial working-capital investment is a cash outflow, while its later
recovery is a cash inflow.
C) The working-capital investment is an operating expense and should be deducted from EBIT
,3|Page
every year.
D) Only the recovered working capital affects project cash flow.
Rationale: B is correct because an increase in net working capital requires an immediate cash
investment. Although it may not appear as an expense on the income statement, it ties up cash
and therefore affects project cash flows. Recovery at project termination releases that cash. A
and D ignore the cash-flow effect of the initial investment. C incorrectly treats a balance-sheet
investment as a recurring operating expense.
Q3: An investor can choose between two mutually exclusive projects. Project A has an IRR of
19% and an NPV of $80,000, while Project B has an IRR of 16% and an NPV of $125,000 at the
firm's 10% required return. Which project should normally be selected?
A) Project A because its IRR is higher.
B) Project B because it produces the greater positive NPV.
C) Project A because IRR is always superior to NPV.
D) Either project because both have positive NPVs.
Rationale: B is correct because NPV directly measures the increase in shareholder wealth
expected from undertaking a project, assuming the cash flows and discount rate are appropriate.
Project B creates $125,000 of value versus $80,000 for A. A is incorrect because a higher IRR
does not necessarily mean greater value, especially for mutually exclusive projects. C is false
because NPV is generally the preferred decision criterion for value maximization. D is incorrect
because mutually exclusive projects require choosing the one that creates greater value.
Q4: A firm is considering replacing an existing machine. The old machine has a current market
value of $70,000 but a book value of $40,000. The firm's tax rate is 25%. If the machine is sold
today, what is the after-tax cash flow from the sale?
A) $40,000
B) $62,500
C) $62,500
D) $70,000
Rationale: C is correct. The machine produces a taxable gain of $70,000 − $40,000 = $30,000.
The tax on the gain is $30,000 × 25% = $7,500. Therefore, the after-tax proceeds are $70,000 −
$7,500 = $62,500. A is merely the book value. B does not reflect the correct tax calculation. D
ignores the tax liability created by the gain.
Q5: An investor deposits $10,000 into an account earning 8% annually. Interest is compounded
quarterly. Approximately how much will the account contain after three years?
A) $12,400
B) $12,512
C) $12,683
D) $13,200
, 4|Page
Rationale: C is correct. With quarterly compounding, the periodic rate is 8%/4 = 2%, and there
are 3 × 4 = 12 periods. The future value is approximately $10,000(1.02)^12 = $12,683. A and B
underestimate the effect of quarterly compounding. D overstates the accumulated value.
Q6: A bond has a $1,000 face value, a 7% annual coupon rate, and 10 years remaining to
maturity. Market interest rates for bonds of comparable risk rise from 7% to 9%. What should
happen to the bond's market price?
A) It should rise above $1,000 because the bond still pays a fixed coupon.
B) It should remain exactly at $1,000 until maturity.
C) It should fall below $1,000 because its fixed coupon payments are less attractive relative
to newly issued bonds.
D) It should rise because higher market rates increase all future cash flows.
Rationale: C is correct because bond prices and market yields move inversely. Existing bonds
with a 7% coupon become less valuable when comparable securities offer 9%. The bond must
sell at a discount so that a buyer's total expected return is competitive with the market. A and D
incorrectly assume higher market rates increase the value of existing fixed payments. B is true
only if the market yield equals the coupon rate.
Q7: A company estimates that its required return on common equity is 12%, its after-tax cost of
debt is 5%, and its capital structure consists of 60% equity and 40% debt. What is its
approximate WACC?
A) 5.0%
B) 7.0%
C) 9.2%
D) 12.0%
Rationale: C is correct. WACC = (0.60 × 12%) + (0.40 × 5%) = 7.2% + 2.0% = 9.2%. A
represents only the after-tax debt cost. B does not correctly weight the components. D represents
only the equity cost and ignores debt financing.
Q8: A company has annual credit sales of $18 million and average accounts receivable of $3
million. Assuming a 365-day year, approximately how many days of sales are tied up in
receivables?
A) 30.4 days
B) 45.0 days
C) 60.8 days
D) 90.2 days
Rationale: C is correct. The receivables turnover ratio is $18 million/$3 million = 6 times.
Average collection period is approximately 365/6 = 60.8 days. A and B imply substantially faster
collection than the firm's actual turnover. D overstates the collection period.
