CORPORATE FINANCE FINAL
PRACTICE EXAM QUESTIONS WITH
COMPLETE SOLUTIONS
The MM theory with taxes implies that firms should issue maximum debt. In practice,
this does not occur because: - ANSWER-bankruptcy is a disadvantage to debt.
The free cash flow hypothesis states that: - ANSWER-issuing debt requires payments to
creditors thereby reducing the ability of managers to waste resources.
The optimal capital structure has been achieved when the: - ANSWER-present value of
the financial distress costs equals the present value of the tax shield on debt
The pecking order states that firms should: - ANSWER-use internal financing first.
Which one of the following statements is true? - ANSWER-Investors will generally view
an increase in debt as a positive sign for the firm's future value.
Which one of these best exemplifies "milking the property"? - ANSWER-A firm with high
financial distress paying additional dividends
The flow-to-equity (FTE) approach in capital budgeting is defined to be the: - ANSWER-
discounting of the levered cash flows to the equity holders for a project at the required
return on equity.
In calculating the NPV using the flow-to-equity approach the discount rate is the: -
ANSWER-cost of equity for the levered firm.
To calculate the adjusted present value, one will: - ANSWER-add the additional effects
of financing to the all equity project value.
The term (B x RB) gives the: - ANSWER-cost of debt interest tax shield per year.
A key difference between the APV, WACC, and FTE approaches to valuation is: -
ANSWER-how debt effects are considered; i.e. the target debt to value ratio and the
level of debt.
The acceptance of a capital budgeting project is usually evaluated on its own merits.
That is, capital budgeting decisions are treated separately from capital structure
decisions. In reality, these decisions may be highly interwoven. This may result in: -
ANSWER-firms accepting some negative NPV all equity projects because changing the
capital structure adds enough positive leverage tax shield value to create a positive
NPV.
, The market's reaction to the announcement of a change in the firm's dividend payout is
likely the: - ANSWER-information content effect.
The ability of shareholders to undo the dividend policy of the firm and create an
alternative dividend payment policy via reinvesting dividends or selling shares of stock
is called (a): - ANSWER-homemade dividends.
The date before which a new purchaser of stock is entitled to receive a declared
dividend, but on or after which she does not receive the dividend, is called the _____
date. - ANSWER-ex-dividend
All else equal, the market value of a stock will tend to decrease by roughly the amount
of the dividend on the: - ANSWER-ex-dividend date.
The information content of a dividend increase generally signals that: - ANSWER-
management believes that the future earnings of the firm will be strong.
From a tax-paying investor's point of view, a stock repurchase: - ANSWER-is more
desirable than a cash dividend.
In an efficient market, ignoring taxes and time value, the price of stock should: -
ANSWER-decrease by the amount of the dividend immediately on the ex-dividend date.
The dividend-irrelevance proposition of Miller and Modigliani depends on the following
relationship between investment policy and dividend policy - ANSWER-The investment
policy is set before the dividend decision and not changed by dividend policy.
You own 300 shares of Abco, Inc. stock. The company has stated that it plans on
issuing a dividend of $.60 a share one year from today and then issuing a final
liquidating dividend of $2.20 a share two years from today. Your required rate of return
is 9%. Ignoring taxes, what is the value of one share of this stock today? - ANSWER-
$2.40
Thompson & Thomson is an all-equity firm that has 280,000 shares of stock
outstanding. The company is in the process of borrowing $2.4 million at 5.5 percent
interest to repurchase 75,000 shares of the outstanding stock. What is the value of this
firm if you ignore taxes? - ANSWER-$8,960,000
Firm value = ($2,400,000/75,000)(280,000) = $8,960,000
MM Proposition I with no tax supports the argument that: - ANSWER-it is completely
irrelevant how a firm arranges its finances.
Which method(s) is(are) most applicable if a project's debt level is known over the life of
the project? - ANSWER-APV
PRACTICE EXAM QUESTIONS WITH
COMPLETE SOLUTIONS
The MM theory with taxes implies that firms should issue maximum debt. In practice,
this does not occur because: - ANSWER-bankruptcy is a disadvantage to debt.
The free cash flow hypothesis states that: - ANSWER-issuing debt requires payments to
creditors thereby reducing the ability of managers to waste resources.
The optimal capital structure has been achieved when the: - ANSWER-present value of
the financial distress costs equals the present value of the tax shield on debt
The pecking order states that firms should: - ANSWER-use internal financing first.
Which one of the following statements is true? - ANSWER-Investors will generally view
an increase in debt as a positive sign for the firm's future value.
Which one of these best exemplifies "milking the property"? - ANSWER-A firm with high
financial distress paying additional dividends
The flow-to-equity (FTE) approach in capital budgeting is defined to be the: - ANSWER-
discounting of the levered cash flows to the equity holders for a project at the required
return on equity.
In calculating the NPV using the flow-to-equity approach the discount rate is the: -
ANSWER-cost of equity for the levered firm.
To calculate the adjusted present value, one will: - ANSWER-add the additional effects
of financing to the all equity project value.
The term (B x RB) gives the: - ANSWER-cost of debt interest tax shield per year.
A key difference between the APV, WACC, and FTE approaches to valuation is: -
ANSWER-how debt effects are considered; i.e. the target debt to value ratio and the
level of debt.
The acceptance of a capital budgeting project is usually evaluated on its own merits.
That is, capital budgeting decisions are treated separately from capital structure
decisions. In reality, these decisions may be highly interwoven. This may result in: -
ANSWER-firms accepting some negative NPV all equity projects because changing the
capital structure adds enough positive leverage tax shield value to create a positive
NPV.
, The market's reaction to the announcement of a change in the firm's dividend payout is
likely the: - ANSWER-information content effect.
The ability of shareholders to undo the dividend policy of the firm and create an
alternative dividend payment policy via reinvesting dividends or selling shares of stock
is called (a): - ANSWER-homemade dividends.
The date before which a new purchaser of stock is entitled to receive a declared
dividend, but on or after which she does not receive the dividend, is called the _____
date. - ANSWER-ex-dividend
All else equal, the market value of a stock will tend to decrease by roughly the amount
of the dividend on the: - ANSWER-ex-dividend date.
The information content of a dividend increase generally signals that: - ANSWER-
management believes that the future earnings of the firm will be strong.
From a tax-paying investor's point of view, a stock repurchase: - ANSWER-is more
desirable than a cash dividend.
In an efficient market, ignoring taxes and time value, the price of stock should: -
ANSWER-decrease by the amount of the dividend immediately on the ex-dividend date.
The dividend-irrelevance proposition of Miller and Modigliani depends on the following
relationship between investment policy and dividend policy - ANSWER-The investment
policy is set before the dividend decision and not changed by dividend policy.
You own 300 shares of Abco, Inc. stock. The company has stated that it plans on
issuing a dividend of $.60 a share one year from today and then issuing a final
liquidating dividend of $2.20 a share two years from today. Your required rate of return
is 9%. Ignoring taxes, what is the value of one share of this stock today? - ANSWER-
$2.40
Thompson & Thomson is an all-equity firm that has 280,000 shares of stock
outstanding. The company is in the process of borrowing $2.4 million at 5.5 percent
interest to repurchase 75,000 shares of the outstanding stock. What is the value of this
firm if you ignore taxes? - ANSWER-$8,960,000
Firm value = ($2,400,000/75,000)(280,000) = $8,960,000
MM Proposition I with no tax supports the argument that: - ANSWER-it is completely
irrelevant how a firm arranges its finances.
Which method(s) is(are) most applicable if a project's debt level is known over the life of
the project? - ANSWER-APV
