Corporate Finance

Midterm Review
Chapters 1 to 8

THOMPSON RIVERS UNIVERSITY

 Midterm Exam:

Sample Questions

THOMPSON RIVERS UNIVERSITY 2

 Midterm Exam:
Sample Questions: Lecture Note #0

1) A business owned by a solitary individual who has unlimited liability for

its debt is called a:
A. corporation.
B. sole proprietorship.
C. general partnership.
D. limited partnership.
E. limited liability company.

2) Which one of the following is a capital structure decision?

A. determining which one of two projects to accept
B. determining how to allocate investment funds to multiple projects
C. determining the amount of funds needed to finance customer purchases of
a new product
D. determining how much debt should be assumed to fund a project
E. determining how much inventory will be needed to support a project

THOMPSON RIVERS UNIVERSITY 3

 Midterm Exam:
Sample Questions: Lecture Note #0

3) Which one of the following statements is correct?

A. The majority of firms in Asia are structured as corporations.
B. Corporate profits are taxable income to the shareholders when earned.
C. Corporations can raise large amounts of capital generally easier than
partnerships can.
D. Stockholders face no potential losses related to their corporate investment.
E. Corporate shareholders elect the corporate president.

4) Decisions made by financial managers should primarily focus on

increasing which one of the following?
A. size of the firm
B. growth rate of the firm
C. gross profit per unit produced
D. market value per share of outstanding stock
E. total sales

THOMPSON RIVERS UNIVERSITY 4

 Midterm Exam:
Summary of Key Points: Lecture Note #1

1) The cash flow related to interest payments less any net new borrowing
is called the:
A. operating cash flow.
B. capital spending cash flow.
C. net working capital.
D. cash flow from assets.
E. cash flow to creditors.

2) Cash flow to stockholders is defined as:

A. the total amount of interest and dividends paid during the past year.
B. the change in total equity over the past year.
C. cash flow from assets plus the cash flow to creditors.
D. operating cash flow minus the cash flow to creditors.
E. dividend payments less net new equity raised.

THOMPSON RIVERS UNIVERSITY 5

 Midterm Exam:
Summary of Key Points: Lecture Note #1
3) Bonner Collision has shareholders' equity of $141,800. The firm owes a total
of $126,000 of which 60 percent is payable within the next year. The firm net
fixed assets of $161,900. What is the amount of the net working capital?
A. $25,300 Answer:
B. $30,300 Current liabilities = 0.60 x $126,000 = $75,600
C. $75,600 Total assets = $141,800 + $126,000 = $267,800
D. $86,300 Current assets = $267,800 - $161,900 = $105,900
E. $111,500 Net working capital = $105,900 - $75,600 = $30,300

4) Winston Industries had sales of $843,800 and costs of $609,900. The firm
paid $38,200 in interest and $18,000 in dividends. It also increased retained
earnings by $62,138 for the year. The depreciation was $76,400. What is the
average tax rate? Answer:
A. 32.83 percent Earnings before taxes = $843,800 - $609,900 -
B. 33.33 percent $76,400 - $38,200 = $119,300
C. 38.17 percent Net income = $18,000 + $62,138 = $80,138
D. 43.39 percent Taxes = $119,300 - $80,138 = $39,162
E. 48.87 percent Tax rate = $39,162/$119,300 = 32.83 percent

THOMPSON RIVERS UNIVERSITY 6

 Midterm Exam:
Summary of Key Points: Lecture Note #1
5) The 2011 balance sheet of The Beach Shoppe showed long-term debt of
$2.1 million, and the 2012 balance sheet showed long-term debt of $2.3
million. The 2012 income statement showed an interest expense of
$250,000. What was the cash flow to creditors for 2012?
A. -$200,000
B. -$150,000 Answer:
C. $50,000 Cash flow to creditors
D. $200,000 = $250,000 - ($2,300,000 - $2,100,000)
= $50,000
E. $450,000

6) An increase in which one of the following will increase a firm's quick

ratio without affecting its cash ratio?
A. accounts payable
B. cash
C. inventory
D. accounts receivable
E. fixed assets

THOMPSON RIVERS UNIVERSITY 7

 Midterm Exam:
Summary of Key Points: Lecture Note #1
7) The 2011 balance sheet of The Sports Store showed $800,000 in the
common stock account and $6.7 million in the additional paid-in surplus
account. The 2012 balance sheet showed $872,000 and $8 million in the
same two accounts, respectively. The company paid out $600,000 in cash
dividends during 2012. What is the cash flow to stockholders for 2012?
A. -$1,372,000
B. -$772,000 Answer:
C. -$628,000 Cash flow to stockholders
D. $372,000 = $600,000 - [($872,000 + $8,000,000) - ($800,000 + $6,700,000)
E. $1,972,000 = -$772,000

8) Coulter Supply has a total debt ratio of 0.47. What is the equity multiplier?
A. 0.89
B. 1.13 Answer:
C. 1.47 Debt-equity ratio = 0.47/(1 - 0.47) = 0.89
D. 1.89 Equity multiplier = 1 + 0.89 = 1.89
E. 2.13

THOMPSON RIVERS UNIVERSITY 8

 Midterm Exam:
Summary of Key Points: Lecture Note #1
9) The Du Pont identity can be used to help managers answer which of the
following questions related to a firm's operations?
I. How many sales dollars has the firm generated per each dollar of assets?
II. How many dollars of assets has a firm acquired per each dollar in
shareholders' equity?
III. How much net profit is a firm generating per dollar of sales?
IV. Does the firm have the ability to meet its debt obligations in a timely
manner?

A. I and III only

B. II and IV only
C. I, II, and III only
D. II, III and IV only
E. I, II, III, and IV

THOMPSON RIVERS UNIVERSITY 9

 Midterm Exam:
Summary of Key Points: Lecture Note #1
10) The Flower Shoppe has accounts receivable of $3,709, inventory of
$4,407, sales of $218,640, and cost of goods sold of $167,306. How
many days does it take the firm to both sell its inventory and collect the
payment on the sale assuming that all sales are on credit?
A. 14.67 days
B. 15.81 days Answer:
C. 16.23 days Days in inventory = 365/($167,306/$4,407) = 9.614 days
D. 17.18 days Days' sales in receivables = 365/($218,640/$3,709) = 6.192 days
E. 17.47 days Total days in inventory and receivables = 9.614 + 6.192 = 15.81 days

11) A firm has a debt-equity ratio of 57 percent, a total asset turnover of

1.12, and a profit margin of 4.9 percent. The total equity is $511,640.
What is the amount of the net income?
A. $28,079
B. $35,143 Answer:
C. $44,084 Return on equity = 0.049 x 1.12 x (1 + 0.57) = 0.0861616
D. $47,601 Net income = $511,640 x 0.0861616 = $44,084
E. $52,418
THOMPSON RIVERS UNIVERSITY 10
 Midterm Exam:
Summary of Key Points: Lecture Note #1
12) Which one of the following will cause the sustainable growth rate to
equal to internal growth rate?
A. dividend payout ratio greater than 1.0
B. debt-equity ratio of 1.0
C. retention ratio between 0.0 and 1.0
D. equity multiplier of 1.0
E. zero dividend payments
Answer:
Equity multiplier = Total Assets / Total Equity
ROA = Net Income / Total Assets
ROE = Net Income / Total Equity = ROA x Equity Multiplier

THOMPSON RIVERS UNIVERSITY 11

 Midterm Exam:
Summary of Key Points: Lecture Note #1
13) A firm has a retention ratio of 45 percent and a sustainable growth rate
of 6.2 percent. The capital intensity ratio is 1.2 and the debt-equity ratio
is 0.64. What is the profit margin?
A. 6.28 percent Answer:
B. 7.67 percent 0.062 = [ROE × 0.45]/[1 - (ROE × 0.45)]; ROE = 0.129734
C. 9.49 percent 0.129734 = PM × (1/1.2) × (1 + 0.64); PM = 9.49 percent
D. 12.38 percent
E. 14.63 percent Note: Capital Intensity Ratio = Total Assets / Sales
= 1 / Total Asset Turnover
14) The Two Sisters has a 9 percent return on assets and a 75 percent
retention ratio. What is the internal growth rate?
A. 6.50 percent
B. 6.75 percent Answer:
C. 6.97 percent Internal growth rate
D. 7.24 percent = (0.09 x 0.75)/[1 - (0.09 x 0.75)] = 7.24 percent
E. 7.38 percent

THOMPSON RIVERS UNIVERSITY 12

 Midterm Exam:
Summary of Key Points: Lecture Note #1
15) The most recent financial statements for Watchtower, Inc. are shown
here (assuming no income taxes):

Assets and costs are proportional to sales. Debt and equity are not. No
dividends are paid. Next year's sales are projected to be $5,002. What is the
amount of the external financing need?
A. $197 Answer:
B. $203
C. $211 Sales increase = ($5,002 - $4,100)/$4,100 = 0.22
EFN= $11,114 - $10,911 = $203
D. $218
E. $223

THOMPSON RIVERS UNIVERSITY 13

 Midterm Exam:
Sample Questions: Lecture Note #2
1) You hope to buy your dream car four years from now. Today, that car
costs $82,500. You expect the price to increase by an average of 4.8
percent per year over the next four years. How much will your dream car
cost by the time you are ready to buy it?
A. $98,340.00 Answer:
Future value = $82,500 x (1 + 0.048)4 = $99,517.41
B. $98,666.67
C. $99,517.41
D. $99,818.02
E. $100,023.16

2) You would like to give your daughter $75,000 towards her college
education 17 years from now. How much money must you set aside
today for this purpose if you can earn 8 percent on your investments?
A. $18,388.19 Answer:
B. $20,270.17 Present value = $75,000 x [1/(1 + 0.08)17] = $20,270.17
C. $28,417.67
D. $29,311.13
E. $32,488.37
THOMPSON RIVERS UNIVERSITY 14
 Midterm Exam:
Sample Questions: Lecture Note #2
3) One year ago, you invested $1,800. Today it is worth $1,924.62. What rate
of interest did you earn?
A. 6.59 percent Answer:
B. 6.67 percent $1,924.62 = $1,800 x (1 + r)1
r = 6.92 percent
C. 6.88 percent
D. 6.92 percent
E. 7.01 percent

4) Some time ago, Julie purchased eleven acres of land costing $36,900.
Today, that land is valued at $214,800. How long has she owned this land if
the price of the land has been increasing at 10.5 percent per year?
A. 13.33 years Answer:
B. 16.98 years $214,800 = $36,900 x (1 + 0.105)t
C. 17.64 years t = 17.64 years
D. 19.29 years
E. 21.08 years

THOMPSON RIVERS UNIVERSITY 15

 Midterm Exam:
Sample Questions: Lecture Note #2
5) Your employer contributes $75 a week to your retirement plan. Assume that
you work for your employer for another 20 years and that the applicable
discount rate is 7.5 percent. Given these assumptions, what is this employee
benefit worth to you today?
A. $40,384.69 Answer:
B. $42,618.46
C. $44,211.11
D. $44,306.16
E. $44,987.74

6) What is the future value of $15,000 a year for 30 years at 12 percent interest?
A. $2,878,406
B. $3,619,990 Answer:
C. $3,711,414
D. $3,989,476
E. $4,021,223
THOMPSON RIVERS UNIVERSITY 16
 Midterm Exam:
Sample Questions: Lecture Note #2
7) Gene's Art Gallery is notoriously known as a slow-payer. The firm
currently needs to borrow $27,500 and only one company will even deal
with them. The terms of the loan call for daily payments of $100. The first
payment is due today. The interest rate is 21.9 percent, compounded daily.
What is the time period of this loan? Assume a 365 day year.
A. 264.36 days Answer:
B. 280.81 days
C. 300.43 days
D. 316.46 days
E. 341.09 days
𝑃𝑃𝑃𝑃𝑃𝑃𝐷𝐷𝐷𝐷𝐷𝐷 = 𝑃𝑃𝑃𝑃𝑃𝑃 × (1 + 𝑟𝑟)
You are basically, bringing the PVA
one period forward
𝐶𝐶 1
𝑃𝑃𝑃𝑃𝑃𝑃𝐷𝐷𝐷𝐷𝐷𝐷 = 𝐶𝐶 + × 1 −
𝑟𝑟 (1 + 𝑟𝑟)𝑁𝑁−1
𝐶𝐶(1 + 𝑟𝑟) 1
= × 1−
𝑟𝑟 (1 + 𝑟𝑟)𝑁𝑁
THOMPSON RIVERS UNIVERSITY 17
 Midterm Exam:
Sample Questions: Lecture Note #2
8) You have been investing $250 a month for the last 13 years. Today, your
investment account is worth $73,262. What is your average rate of return on
your investments?
A. 8.94 percent
B. 9.23 percent
C. 9.36 percent
D. 9.41 percent
E. 9.78 percent
Answer:

9) You just signed a consulting contract that will pay you $35,000, $52,000, and
$80,000 annually at the end of the next three years, respectively. What is the
present value of these cash flows given a 10.5 percent discount rate?
A. $133,554
B. $142,307 Answer:
C. $148,880
D. $151,131
E. $156,910
THOMPSON RIVERS UNIVERSITY 18
 Midterm Exam:
Sample Questions: Lecture Note #2

10) You want to buy a new sports coupe for $41,750, and the finance office
at the dealership has quoted you an 8.6 percent APR loan compounded
monthly for 48 months to buy the car. What is the effective interest rate
on this loan?
A. 8.28 percent Answer:
B. 8.41 percent EAR = [1 + (0.086/12)]12 - 1 = 8.95 percent
C. 8.72 percent
D. 8.87 percent
E. 8.95 percent

THOMPSON RIVERS UNIVERSITY 19

 Midterm Exam:
Sample Questions: Lecture Note #3
1) The Fisher effect is defined as the relationship between which of the
following variables?
A. default risk premium, inflation risk premium, and real rates
B. nominal rates, real rates, and interest rate risk premium
C. interest rate risk premium, real rates, and default risk premium
D. real rates, inflation rates, and nominal rates
E. real rates, interest rate risk premium, and nominal rates

2) Which of the following relationships apply to a par value bond?

I. coupon rate < yield-to-maturity
II. current yield = yield-to-maturity
III. market price = call price
IV. market price = face value
A. I and II only
B. I and III only
C. II and IV only
D. I, II, and III only
E. II, III, and IV only
THOMPSON RIVERS UNIVERSITY 20
 Midterm Exam:
Sample Questions: Lecture Note #3
3) As a bond's time to maturity increases, the bond's sensitivity to interest
rate risk:
A. increases at an increasing rate.
B. increases at a decreasing rate.
C. increases at a constant rate.
D. decreases at an increasing rate.
E. decreases at a decreasing rate.

4) Sylvan Trees has a 7 percent coupon bond on the market with ten years left
to maturity. The bond makes annual payments and currently sells for
$861.20. What is the yield-to-maturity?
A. 8.50 percent Answer:
B. 8.68 percent This cannot be solved directly and requires the use of the calculator
C. 8.92 percent
D. 9.18 percent
E. 9.27 percent

THOMPSON RIVERS UNIVERSITY 21

 Midterm Exam:
Sample Questions: Lecture Note #3
5) Dexter Mills issued 20-year bonds a year ago at a coupon rate of 11.4
percent. The bonds make semiannual payments. The yield-to-maturity on
these bonds is 9.2 percent. What is the current bond price?
A. $985.55
B. $991.90 Answer:
C. $1,192.16
D. $1,195.84
E. $1,198.00

THOMPSON RIVERS UNIVERSITY 22

 Midterm Exam:
Sample Questions: Lecture Note #4

1) An increase in which of the following will increase the current value of a

stock according to the dividend growth model?
I. dividend amount
II. number of future dividends, provided the current number is less than
infinite
III. discount rate
IV. dividend growth rate

A. I and II only
B. III and IV only
C. I, II, and III only
D. I, II, and IV only
E. I, II, III, and IV

THOMPSON RIVERS UNIVERSITY 23

 Midterm Exam:
Sample Questions: Lecture Note #4
2) Miller Brothers Hardware paid an annual dividend of $1.15 per share last
month. Today, the company announced that future dividends will be
increasing by 2.6 percent annually. If you require a 12 percent rate of return,
how much are you willing to pay to purchase one share of this stock today?
A. $12.23
B. $12.55 Answer:
C. $12.67
D. $12.72
E. $12.88

3) Denver Shoppes will pay an annual dividend of $1.46 a share next year with
future dividends increasing by 4.2 percent annually. What is the market rate
of return if the stock is currently selling for $38.90 a share?
A. 6.55 percent
B. 7.13 percent Answer:
C. 7.46 percent
D. 7.95 percent
E. 8.29 percent
THOMPSON RIVERS UNIVERSITY 24
 Midterm Exam:
Sample Questions: Lecture Note #4
4) Diets For You announced today that it will begin paying annual
dividends next year. The first dividend will be $0.12 a share. The
following dividends will be $0.15, $0.20, $0.50, and $0.60 a share
annually for the following 4 years, respectively. After that, dividends are
projected to increase by 4 percent per year. How much are you willing to
pay to buy one share of this stock today if your desired rate of return is
8.5 percent?
A. $9.67
B. $9.94
C. $10.38
D. $10.50
Answer:
E. $10.86

THOMPSON RIVERS UNIVERSITY 25

 Midterm Exam:
Answer Key to Sample Questions
Lecture Note #0 Lecture Note #2 Lecture Note #4
1) B 1) C 6) B 1) D
2) D 2) B 7) C 2) B
3) C 3) D 8) A 3) D
4) D 4) C 9) A 4) C
5) A 10) E
Lecture Note #1
1) E 11) C Lecture Note #3
2) E 12) D 1) D
3) B 13) C 2) C
4) A 14) D 3) B
5) C 15) B 4) D
6) D 5) D
7) B
8) D
9) C
10) B

THOMPSON RIVERS UNIVERSITY 26