WorksheetsAdvanced Corporate Finance Quiz
Total questions: 42
Worksheet time: 21mins
Which of the following best describes 'systematic risk' in capital budgeting?
Risk unique to a firm
Risk that can be diversified away
Market-related risk affecting all firms
Operational risk due to management decisions
The certainty equivalent approach in project evaluation adjusts the project's cash flows to:
Reflect inflation only
Remove risk so they can be discounted at the risk-free rate
Increase the discount rate
Account for sunk costs
Which technique is used to examine how the NPV changes when one variable is changed at a time?
Sensitivity analysis
Scenario analysis
Simulation analysis
Break-even analysis
In decision tree analysis, a 'chance node' represents:
A deterministic outcome
A point where managerial choice is made
A probabilistic event or uncertainty
The final payoff
Using a risk-adjusted discount rate for a risky project generally:
Lowers the discount rate
Raises the PV of future cash flows
Uses the risk-free rate only
Increases the discount rate to reflect risk
Standard deviation as a measure of risk indicates:
The average return
The variability of possible outcomes around the mean
The maximum possible loss
The probability-weighted cash flow
Which of the following statements about coefficient of variation (CV) is correct?
CV = mean / standard deviation
CV helps compare risk across projects with different expected returns
CV is only used for normally distributed returns
CV gives the absolute amount of risk
Scenario analysis in capital budgeting typically involves:
Changing one variable at a time
Creating optimistic, pessimistic and most likely cases
Using historical averages only
Ignoring probabilities
The main purpose of a sensitivity analysis is to:
Provide exact future cash flows
Identify which variables have the greatest impact on project viability
Replace the need for probabilistic models
Determine tax effects
A project's NPV increases when the discount rate decreases because:
Future cash flows are discounted less heavily
Future cash flows become larger
Taxes decrease
Initial investment decreases
Which of the following is NOT a source of risk in capital budgeting?
Market demand uncertainty
Exchange rate fluctuations
Firm's current dividend policy
Technological changes
The use of Monte Carlo simulation in capital budgeting is primarily to:
Generate a single-point estimate of NPV
Model the distribution of possible project outcomes by simulating many scenarios
Eliminate the need for discounting
Compute historical returns
According to Modigliani and Miller (without taxes), the value of a firm is:
Higher with more debt
Lower with more debt
Independent of its capital structure
Dependent on dividend policy
The Net Operating Income (NOI) approach suggests that:
WACC changes with capital structure
Firm value is independent of capital structure
Increasing debt will increase the firm's value
Cost of equity remains constant
The Net Income (NI) approach assumes that:
Both cost of debt and cost of equity change with leverage
WACC remains constant as leverage changes
Increasing leverage always reduces WACC and increases firm value
Taxes are the only determinant of capital structure
The traditional approach to capital structure holds that:
There is an optimal debt-equity mix that minimizes WACC
Firm value is always maximized at zero debt
Modigliani-Miller assumptions always hold
Equity is always cheaper than debt
Under MM with corporate taxes, the value of a levered firm compared to an unlevered firm is:
The same
Less by the PV of tax shield
Greater by the PV of tax shield from debt interest
Dependent only on market imperfections
Which of the following will reduce WACC, all else equal?
Increasing expected inflation
Replacing expensive equity with relatively cheap debt when interest tax shields exist
Reducing leverage to zero
Increasing required return on equity
Financial leverage primarily affects a firm's:
Operating income
Business risk
Financial risk and EPS variability
Product pricing strategy
The cost of equity in the presence of debt is generally measured using:
Risk-free rate only
CAPM or other models that reflect equity risk and leverage
Coupon rate of debt
Book rate of return
Which of the following is a key assumption in the Modigliani-Miller propositions?
No taxes, no bankruptcy costs, and perfect capital markets
Existence of transaction costs
Firms can time the market perfectly
Investors have different information
In practical terms, a firm's target capital structure is often guided by:
Historical book values only
Trade-off between tax benefits of debt and bankruptcy costs
MM theorem without taxes exclusively
Random selection each year
An increase in business risk (operating risk) will generally:
Allow the firm to take on more financial leverage safely
Reduce the firm's capacity to bear additional debt
Not affect capital structure decisions
Lower cost of debt
When calculating WACC, market values should be used because:
They are easier to find than book values
They reflect current investor expectations and opportunity costs
Book values always understate debt
Tax records require market values
According to Walter's model, the choice of dividend policy depends on:
The firm's current share price only
Relationship between internal rate of return (r) and cost of capital (k)
Market interest rates only
Liquidity ratios
Gordon's (Bird-in-the-Hand) model suggests that:
Investors prefer higher retained earnings over dividends
Dividend growth is irrelevant to share valuation
Higher dividends are preferred because they reduce uncertainty of returns
Firms should never pay dividends
MM's dividend irrelevance theory (without taxes) states that:
Dividend policy affects firm value
Dividend policy is irrelevant in perfect capital markets
Investors cannot create homemade dividends
Taxes make dividend decisions critical
In Walter's model if r > k, the firm should:
Retain earnings for internal investment
Pay all earnings as dividends
Neither retain nor distribute
Issue new equity
Gordon growth model requires which key assumption for valuation?
Dividends grow at a constant rate forever
Dividends are zero
Returns are nonexistent
Firm has no shareholders
Which of the following is a limitation common to many dividend models?
They perfectly capture shareholder preferences
They often assume constant growth rates and ignore market imperfections
They account for all taxes and transaction costs accurately
They require no assumptions about future earnings
'Residual dividend policy' implies that dividends are paid from:
A fixed percentage of earnings every year
Earnings left after financing all positive NPV investment opportunities
New equity issuance only
Debt restructuring proceeds
A stock repurchase (buyback) compared to cash dividends typically:
Reduces earnings per share immediately while increasing share count
Is treated identically by all investors for tax purposes
Reduces outstanding shares and can increase EPS if shares are retired
Forces the firm to increase future dividends
In presence of differential taxation (dividends taxed higher than capital gains), investors might:
Prefer dividends always
Prefer capital gains for tax efficiency
Not care about tax differences
Prefer neither
Which model values a share as the present value of all expected future dividends?
Free cash flow model
CAPM
Dividend discount model (DDM)
Residual income model
A firm's stable dividend policy is often chosen to:
Maximize short-term EPS only
Minimize share price volatility and signal stable earnings
Ignore investor preferences
Ensure no retained earnings
Working capital is defined as:
Total assets minus fixed assets
Current assets minus current liabilities
Long-term liabilities only
Equity minus debt
The operating cycle of a firm measures the time between:
Purchase of raw materials and collection of cash from sales
Issuance of shares and payment of dividends
Purchase of machinery and its disposal
Loan disbursal and repayment
In estimating working capital using the operating cycle method, which components are crucial?
Raw material holding period, work-in-progress period, finished goods period, receivables collection period, and payables period
Only cash balances
Long-term investments
Dividend payout ratio
A conservative working capital policy implies:
Lower current asset levels and higher liquidity risk
Higher levels of current assets and lower risk of stockouts
No need for short-term financing
Zero inventories
Cash conversion cycle is computed as:
Inventory period + Receivables period - Payables period
Inventory period - Receivables period + Payables period
Receivables period + Payables period
Payables period - Inventory period
Which of the following will reduce working capital requirement?
Faster inventory turnover
Longer receivables collection period
Increased raw material holding period
Higher finished goods inventory
Collection float refers to:
Time taken for goods to be manufactured
Time between customer payment and when cash is available for use
Time taken to convert cash into inventory
Time needed to pay suppliers
