Corporate Finance Flashcards
A primary responsibility of a board’s audit committee does not include the:
A.
proper application of accounting policies.
B.
adoption of proper corporate governance.
C.
recommendation of remuneration for the external auditor(s).
34, Blue Box
B is correct. The adoption of proper corporate governance is the responsibility of a corporation’s governance committee. Both A and C are incorrect because proper application of accounting policies and the remuneration of external auditors fall under the domain of the audit committee.
Which of the following statements regarding stakeholder management is most accurate?
A.
Company management ensures compliance with all applicable laws and regulations.
B.
Directors are excluded from voting on transactions in which they hold material interest.
C.
The use of variable incentive plans in executive remuneration is decreasing.
34, EoC
5.
B is correct. Often, policies on related-party transactions require that such transactions or matters be voted on by the board (or shareholders), excluding the director holding the interest.
Which of the following statements regarding corporate shareholders is most accurate?
A.
Cross-shareholdings help promote corporate mergers.
B.
Dual-class structures are used to align economic ownership with control.
C.
Affiliated shareholders can protect a company against hostile takeover bids.
34, EoC
C is correct. The presence of a sizable affiliated stockholder (such as an individual, family trust, endowment, or private equity fund) can shield a company from the effects of voting by outside shareholders.
Which of the following statements regarding ESG implementation methods is most accurate?
A.
Negative screening is the most commonly applied method.
B.
Thematic investing considers multiple factors.
C.
The best-in-class strategy excludes industries with unfavorable ESG aspects.
34, EoC
A is correct. Negative screening, which refers to the practice of excluding certain sectors or companies that violate accepted standards in such areas as human rights or environmental concerns, is the most common ESG investment strategy (implementation method).
An investment of $20,000 will create a perpetual after-tax cash flow of $2,000. The required rate of return is 8 percent. What is the investment’ sprofitability index?
A. 1.08.
B. 1.16.
C. 1.25.
35, EoC
C. 1.25 is correct
The present value of future cash flows is PV = 2000/0.08= 25,000.
The profitability index is PI = PV/Investment aka 25,000/20,000=1.25
Freitag Corporation is investing 600 million in distribution facilities. The present value of the
future after-tax cash flows is estimated to be 850 million. Freitag has 200 million outstanding
shares with a current market price of 32.00 per share. This investment is new information, and it is independent of other expectations about the company. What should be the effect of the project on the value of the company and the stock price?
35, Blue Box
The NPV of the project is 850 million - 600 million = 250 million. The total market value of the company prior to the investment is 32.00*200 million shares = 6,400 million. The value of the company should increase by 250 million to 6,650 million. The
price per share should increase by the NPV per share, or 250 million / 200 million shares = 1.25 per share. The share price should increase from 32.00 to 33.25.
Erin Chou is reviewing a profitable investment project that has a conventional cash flow pattern. If the
cash flows for the project, initial outlay, and future after-tax cash flows all double, Chou would predict
that the IRR would:
A. increase and the NPV would increase.
B. stay the same and the NPV would increase.
C. stay the same and the NPV would stay the same.
35, EoC
B is correct. The IRR would stay the same because both the initial outlay and the after-tax cash flows double, so that the return on each dollar invested remains the same. All of the cash flows and their present values double. The difference between total present value of the future cash flows and the initial outlay (the NPV) also doubles.
Shirley Shea has evaluated an investment proposal and found that its payback period is one year, it has
a negative NPV, and it has a positive IRR. Is this combination of results possible?
A. Yes.
B. No, because a project with a positive IRR has a positive NPV.
C. No, because a project with such a rapid payback period has a positive NPV.
35, EoC
A is correct. If the cumulative cash flow in one year equals the outlay and additional cash flows are not very large, this scenario is possible. For example, assume the outlay is 100, the cash flow in Year 1 is 100 and the cash flow in Year 2 is 5. The required return is 10 percent. This project would have a payback of 1.0 years, an NPV of 4.96, and an IRR of 4.77 percent.
An investment has an outlay of 100 and after-tax cash flows of 40 annually for four years. A project
enhancement increases the outlay by 15 and the annual after-tax cash flows by 5. As a result, the
vertical intercept of the NPV profile of the enhanced project shifts:
A. up and the horizontal intercept shifts left.
B. up and the horizontal intercept shifts right.
C. down and the horizontal intercept shifts left.
35, EoC
A is correct. The vertical intercept changes from 60 to 65 (NPV when cost of capital is 0%), and the horizontal intercept (IRR, when NPV equals zero) changes from 21.86 percent to 20.68 percent.
Consider the two projects below. The cash flows as well as the NPV and IRR for the two projects are
given. For both projects, the required rate of return is 10 percent.
Cash Flows Year 0 1 2 3 4 NPV IRR (%) Project 1 100 36 36 36 36 14.12 16.37 Project 2 100 0 0 0 175 19.53 15.02 What discount rate would result in the same NPV for both projects?
A. A rate between 0.00 percent and 10.00 percent.
B. A rate between 10.00 percent and 15.02 percent.
C. A rate between 15.02 percent and 16.37 percent.
35, EoC
B is correct. For these projects, a discount rate of 13.16 percent would yield the same NPV for both (an
NPV of 6.73).
For 1., NPV = 0 at 16.37
For 2., NPV = 0 at 15.02
They are not the same at 10%
For the two NPV to equal, they must meet before either of them hit zero, therefore after 10% but before 15.02% (first one to hit zero is project 2).
Wilson Flannery is concerned that this project has multiple IRRs.
Year 0 1 2 3
Cash flows -50 100 0 -50
How many discount rates produce a zero NPV for this project?
A. One, a discount rate of 0 percent.
B. Two, discount rates of 0 percent and 32 percent.
C. Two, discount rates of 0 percent and 62 percent.
35, EoC
C is correct. Discount rates of 0 percent and approximately 61.8 percent both give a zero NPV.
Rate 0% 20% 40% 60% 61.8% 80% 100%
NPV 0.00 4.40 3.21 0.29 0.00 3.02 6.25
We know it’s B or C because two points of sign changes therefore two IRRs.
Basically plug in two potential answers as “r” in calculator and see which gives zero/close to zero answers.
With regard to the net present value (NPV) profiles of two projects, the crossover rate is best described
as the discount rate at which:
A. two projects have the same NPV.
B. two projects have the same internal rate of return.
C. a project’s NPV changes from positive to negative.
35, EoC
A is correct. The crossover rate is the discount rate at which the NPV profiles for two projects cross; it is the only point where the NPVs of the projects are the same.
With regard to net present value (NPV) profiles, the point at which a profile crosses the vertical axis is
best described as:
A. the point at which two projects have the same NPV.
B. the sum of the undiscounted cash flows from a project.
C. a project’s internal rate of return when the project’s NPV is equal to zero.
35, EoC
B is correct. The vertical axis represents a discount rate of zero. The point where the profile crosses the
vertical axis is simply the sum of the cash flows.
With regard to net present value (NPV) profiles, the point at which a profile crosses the horizontal axis
is best described as:
A. the point at which two projects have the same NPV.
B. the sum of the undiscounted cash flows from a project.
C. a project’s internal rate of return when the project’s NPV is equal to zero.
35, EoC
C is correct. The horizontal axis represents an NPV of zero. By definition, the project’s IRR equals
an NPV of zero.
With regard to capital budgeting, an appropriate estimate of the incremental cash flows from a project
is least likely to include:
A. externalities.
B. interest costs.
C. opportunity costs.
35, EoC
B is correct. Costs to finance the project are taken into account when the cash flows are discounted at
the appropriate cost of capital; including interest costs in the cash flows would result in doublecounting
the cost of debt.
