Corporate Finance Exam Prep Test Questions with
Correct Answers
Valuation principle
State that we can use current market prices to determine the value today of the costs and
benefits associated with a decision
Net present value rule
The main tool of project evaluation where we weigh the costs and benefits at different points in
time and apply this information to decisions
Time value of money
The difference in value between money today and money in the future i.e. investment
Discount rate
The risk-free interest-rate
NPV decision rule
When making an investment decision take the alternative with the highest NPV. Choosing this
alternative is equivalent to receiving it's NPV in cash today
Accept projects
With positive NPV
Reject projects
With negative NPV
Arbitrage
The practice of buying and selling equivalent goods in different markets to take advantage of a
price difference
,Normal market
A competitive market in which there are no arbitrage opportunities
Law of one price
If equivalent investment opportunities trade simultaneously in different competitive markets
they must trade for the same price in all markets
Financial security
An investment opportunity that trades in a financial market
Separation principle
separate the firms investment decision from its financing choice
Portfolio
A collection of securities
Value additivity
Because security C is equivalent to the portfolio of A and B, by the law of one price they must
have the same price
Stream of cash flows
A series of $ that last several periods
Timeline
Represents a stream of cash flows
Net present value
Present value of benefits minus the present value of costs
Perpetuity
, A stream of equal cash flows that occurrs at regular intervals and lasts forever, such as a British
government bond which is called a consol
Annuity
A stream of equal cash flows paid at regular intervals that ends after a fixed number of
payments
Internal rate of return (IRR)
The interest rate that sets the net present value of the cash flows equal to zero, the interest
rate that equates the present value and cash flow's of an investment opportunity
Compound annual growth rate (CAGR)
When looking at an investment and converting it to an equivalent one year return so they can
compare just two cash flows but assuming that the amount compounds at regular intervals
Effective annual rate (EAR)
Indicates the actual amount of interest that will be earned at the end of one year
Annual percentage rate (APR)
Indicates the amount of simple interest earned in one year without the effect of compounding -
usually less than what you will actually earn
Continuous compounding
Compound the interest every instant
Amortizing loans
Each month you pay interest on the loan plus some of the loan balance
Adjustable rate mortgage (ARM)
Correct Answers
Valuation principle
State that we can use current market prices to determine the value today of the costs and
benefits associated with a decision
Net present value rule
The main tool of project evaluation where we weigh the costs and benefits at different points in
time and apply this information to decisions
Time value of money
The difference in value between money today and money in the future i.e. investment
Discount rate
The risk-free interest-rate
NPV decision rule
When making an investment decision take the alternative with the highest NPV. Choosing this
alternative is equivalent to receiving it's NPV in cash today
Accept projects
With positive NPV
Reject projects
With negative NPV
Arbitrage
The practice of buying and selling equivalent goods in different markets to take advantage of a
price difference
,Normal market
A competitive market in which there are no arbitrage opportunities
Law of one price
If equivalent investment opportunities trade simultaneously in different competitive markets
they must trade for the same price in all markets
Financial security
An investment opportunity that trades in a financial market
Separation principle
separate the firms investment decision from its financing choice
Portfolio
A collection of securities
Value additivity
Because security C is equivalent to the portfolio of A and B, by the law of one price they must
have the same price
Stream of cash flows
A series of $ that last several periods
Timeline
Represents a stream of cash flows
Net present value
Present value of benefits minus the present value of costs
Perpetuity
, A stream of equal cash flows that occurrs at regular intervals and lasts forever, such as a British
government bond which is called a consol
Annuity
A stream of equal cash flows paid at regular intervals that ends after a fixed number of
payments
Internal rate of return (IRR)
The interest rate that sets the net present value of the cash flows equal to zero, the interest
rate that equates the present value and cash flow's of an investment opportunity
Compound annual growth rate (CAGR)
When looking at an investment and converting it to an equivalent one year return so they can
compare just two cash flows but assuming that the amount compounds at regular intervals
Effective annual rate (EAR)
Indicates the actual amount of interest that will be earned at the end of one year
Annual percentage rate (APR)
Indicates the amount of simple interest earned in one year without the effect of compounding -
usually less than what you will actually earn
Continuous compounding
Compound the interest every instant
Amortizing loans
Each month you pay interest on the loan plus some of the loan balance
Adjustable rate mortgage (ARM)
