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September 2014 Professional Examination Level 1

Corporate Finance
Equity Valuation and Analysis
Fixed Income Valuation and Analysis

Multiple Choice Questions and Suggested Solutions

Corporate Finance (1 - 33)

1. Why is it sometimes possible to obtain inconsistent results between Internal Rate

of Return (IRR) and Net Present Value (NPV) for the purposes of comparison
between two or more projects?
A. Because they are measured in different units.
B. Because IRR does not take account of the time value of money.
C. Because NPV does not take account of the time value of money.
D. Because the NPVs 'cross over' as the discount rate is increased.

2. The fundamental principle of the application of Discounted Cash Flow (DCF)

techniques to investment appraisal is _____________
A. To incorporate all incremental cash flows.
B. To incorporate all sunk cost.
C. To incorporate all relevant depreciation.
D. To absorb all company overheads.

3. In finance we refer to the market for relatively long-term financial instruments as

the __________ market.
A. Money.
B. Capital.
C. Primary.
D. Secondary.

4. Which of these activities does not exclusively come within the scope of corporate
financial decision-making?
A. How much should be invested?
B. How much is to be allocated to the marketing budget?
C. Which type of finance should be chosen?
D. How much finance should be raised?

5. Which of the following is a legitimate reason why firm value maximization is

preferred to profit maximization as the ideal goal for the firm?
A. Value takes account of both profit and cash flow.
B. Value or discounted cash flow is less ambiguous than profit.
C. Value takes account of depreciation.
D. Profit is too concerned with the longer term.

6. If the weighting of equity in total capital is 1/3, that of debt is 2/3, the return on
equity is 15% that of debt is 10% and the corporate tax rate is 32%, what is the
Weighted Average Cost of Capital (WACC)?
A. 10.533%
B. 7.533%
C. 9.533%
D. 11.350%

7. Which of the following is not a fundamental assumption made by Modigliani and

A. No taxes.
B. There is imperfect information.
C. Firms can be classified into distinct risk classes.
D. Possible to borrow and lend at the risk-free rate.

8. In calculating the costs of the individual components of a firm's financing, the

corporate tax rate is important to which of the following component cost
A. Ordinary shares.
B. Debt.
C. Preferred stock.
D. Warrants.

9. To a financial analyst, "working capital" means the same thing as ____________

A. Total assets.
B. Fixed assets.
C. Current assets.
D. Current assets minus current liabilities.

10. What is the value of the firm usually based on?

A. The value of debt and equity.
B. The value of equity.
C. The value of debt.
D. The value of assets plus liabilities.

11. Which of the following is an argument for the relevance of dividends?

A. Informational content.
B. Reduction of uncertainty.
C. Some investors' preference for current income.
D. All of the above.

12. The existence of _____________ on the balance sheet generates tax advantages
that directly influence the capital structure of the firm.
A. A large proportion of fixed assets.
B. Long-term debt.
C. Retained earnings.
D. Current assets.

13. Managers are generally defined as _____________

A. Stockholders.
B. Agents.
C. Creditors.
D. Suppliers.
14. Three major risks in international business are ______________
A. Economic, political and people.
B. Political, financial and regulatory.
C. Accounting, management and information.
D. Marketing, ethics and political.

15. Which of the following is an advantage of going public?

A. It allows a firm's founders to diversify their holdings.
B. It increases the liquidity of the stock.
C. It increases the possibility of takeover.
D. (A) and (B) above.

16. Financing costs are ignored in the calculation of cash flows in capital budgeting
analysis because _______________
A. The costs are effectively included in the opportunity cost embedded in the
cost of capital computation.
B. Capital is treated as a non-cash item for capital budgeting analysis.
C. It is more important to measure the risk inherent in the project.
D. All of the above.

17. If the risk-free rate is 3%, the beta (risk measure) of a stock is 2 and the
expected market return over the period is 10%, according to the CAPM the
expected return of the stock would be _______________
A. 17%
B. 20%
C. 29%
D. 15%

18. Which of the following measures compares the risk of an unlevered company to
the risk of the market?
A. Ungeared beta.
B. Geared beta.
C. Portfolio beta.
D. Stock beta.

19. _____________ is a technique which indicates how much a projects NPV will
change in response to a given change in an input variable, other things held
A. Break even analysis.
B. Degree of operating leverage.
C. Sensitivity analysis.
D. Scenario analysis.

20. _____________ arises due to internal factors.

A. Hard rationing.
B. Soft rationing.
C. Single period rationing.
D. All of the above.

21. According to the Capital Asset Pricing Model (CAPM), which of the following
represent the amount of compensation the investor needs for taking on additional
A. (rM - rF)
B. (rM+rF)
C. rF
D. (rM - rF)
22. Which of the following statements applies to Dividend Growth Model?
A. It is difficult to understand and use.
B. It is used for valuing non-listed companies.
C. It is used for valuing debt securities.
D. It does not consider the risk level of a security.

23. A dividend payment made in the form of additional shares, rather than a cash
payout is known as _____________
A. Stock Dividend.
B. Cum Dividend.
C. Ex Dividend.
D. Extra Dividend.

24. ______________ is the distribution of the profits of a company among its

A. Shares.
B. Interest.
C. Commission.
D. Dividend.

25. A firms investment decision is also called the ____________

A. Financing decision.
B. Capital budgeting decision.
C. Liquidity decision.
D. None of the above.

26. What is the first year discount factor if the present value of N644 to be paid at
the end of one year is N500 ?
A. 0.901
B. 1.288
C. 0.776
D. None of the above.

27. Which of the following is not a benefit usually given to common stockholders?
A. Voting rights.
B. Dividends.
C. Stock options.
D. Residual claims.

28. Which of the following investment rules does not use the time value of money
A. The payback period.
B. Internal rate of return.
C. Net present value.
D. All of the above use the time value concept.

29. Long-term government bonds have ____________

A. Interest rate risk.
B. Default risk.
C. Market risk.
D. All of the above.

30. A group of investment bankers who pool their efforts to underwrite a large issue
of a security is known as __________
A. A syndicate.
B. A private placement.
C. A tombstone group.
D. An underwriters group.

31. The method of raising equity capital from existing shareholders by offering them
opportunity to buy securities on pro rata basis is referred to as __________
A. Public issue.
B. Bonus issue.
C. Right issue.
D. Private placement.

32. A company has an expected ROE of 11%. The dividend growth rate will be
___________ if the firm follows a policy of paying 25% of earnings in the form of
A. 3.0%
B. 4.8%
C. 8.25%
D. 9.0%

33. A company is considering the purchase of a metal fabricator that costs N500,000.
Assume a required rate of return of 10%, and the following cash flow schedule:
Year 1 : N300,000
Year 2 : N200,000
Year 3 : N200,000

What is the projects NPV?

A. (N204,300)
B. +N214,300
C. +N152,300
D. +N88,300

Equity Valuation and Analysis (34 - 67)

34. Which of the following is not a factor under the Free Cash Flow to the
Firm (FCFF) Model?
A. Depreciation expense.
B. Capital expenditure.
C. Change in working capital.
D. Principal debt repayment.

35. All of the following factors affect the required rate of return except
A. The economy's risk free rate.
B. Corporate business risk.
C. Return on equity.
D. Country risk.

36. Suppose that the average P/E multiple in the oil industry is 16. Mobil Oil is
expected to have an EPS of N4.50 in the coming year. The intrinsic value of Mobil
Oil stock should be _______________
A. N28.12
B. N35.55
C. N63.00
D. N72.00

37. A growth company can invest in projects that generate a return greater than the
firms ______________
A. Return on equity.
B. Cost of debt.
C. Cost of equity.
D. Cost of capital.

38. Music Doctors Company has a dividend growth rate of 5.6%. If the firm follows a
policy of paying 60% of earnings in the form of dividends, what is the companys
A. 10%
B. 14%
C. 16%
D. 8%

39. Attractive value stocks feature _______________

A. Rapid historical EPS growth.
B. Rapid expected EPS growth.
C. Above average P/E ratios.
D. Below average P/B ratios.

40. A preferred stock will pay a dividend of N7.50 in the upcoming year, and every
year thereafter, i.e., dividends are not expected to grow. You require a return of
10% on this stock. Using the constant growth DDM, what is the intrinsic value of
this preferred stock?
A. N0.75
B. N7.50
C. N64.12
D. None of the above.

41. In a common stock rights offering, the subscription price is generally

A. Set below the current market price of the stock.
B. Set above the current market price of the stock.
C. Set after the stock goes "ex-rights".
D. Set equal to the current market price of the stock.

42. Chelsea Plcs free cash flow for the current year is N6,750,000 and investors
believe that the companys free cash flow will grow by 5% annually forever. If
Chelseas weighted average cost of capital is 15%, what is their enterprise value?
A. N67,500,000
B. N85,350,000
C. N56,780,000
D. N70,875,000

43. The first public sale of company stock to outside investors is called a/an
A. Seasoned equity offering.
B. Shareholders meeting.
C. Initial public offering.
D. Proxy fight.

44. Which statement about ordinary shareholders is incorrect?

A. Shareholders only have a residual claim.
B. Shareholders have precedence over all other claimholders in the case of
C. Shareholders have a voting right.
D. Shareholders are the ultimate owners of a company.
45. What is the market capitalization of a company?
A. The market value of all outstanding debt.
B. The book value of the companys debt.
C. The market value of all outstanding shares.
D. The book value of the companys total equity.

46. Which of the following is not a difficulty associated with valuing ordinary shares?
A. Ordinary shares do not have a specific expiration date.
B. The required rate of return is difficult to estimate.
C. Ordinary shares do not promise a fixed cash flow stream.
D. All of the above are considered difficulties associated with valuing ordinary

47. Biggs Sausages Limited has preferred stock outstanding. This stock pays a
semiannual dividend of N1.25. If the next dividend is paid six months from now
and the annual required return is 10%, what should be the value of the preferred
A. N6.25
B. N25
C. N12.50
D. N50.00

48. If the dividend yield for year one is expected to be 5% based on the current price
of N25, what will the year four dividend be if dividends grow at a constant 6%?
A. N1.33
B. N1.49
C. N1.58
D. N1.67

49. All things being equal, which of the following would likely be associated with a
high growth rate in earnings?
A. Beta = 1.
B. Low risk-free rate.
C. High retention ratio.
D. Low inflation rate.

50. An analyst estimates that XYZs earnings will grow from N3.00 to N4.50 per share
over the next eight years. What is the rate of growth in XYZ earnings?
A. 4.9%
B. 5.2%
C. 6.7%
D. 7.0%

51. A share of George Ltd preferred stock is selling for N65. It pays a dividend of
N4.50 per year and has a perpetual life. The rate of return it is offering investor is
closest to ____________
A. 4.5%
B. 6.5%
C. 6.9%
D. 14.4%

52. When you observe relatively very high price to book ratio, the market is most
likely _____________
A. Bullish.
B. Bearish.
C. Recovering.
D. Uncertain.
53. XYZ stock price is N35, and the dividend per share per year is N2. The
appropriate discount rate is 13%. What is the expected price of XYZ one year
from now?
A. N37.94
B. N39.55
C. N38.13
D. Cannot be determined from the given data

54. The information content of a dividend increase generally signals that

A. The firm has a one-time surplus of cash.
B. The firm has few, if any, net present value projects to pursue.
C. Management believes earnings growth will be strong going forward.
D. The firm has more cash than it needs due to a decline in future orders.

55. Which one of the following does not affect the total equity of a firm but does
increase the number of shares outstanding?
A. Special dividend.
B. Stock split.
C. Share repurchase.
D. Rights offer.

56. Which of the following best describes the constant-growth dividend discount
A. It is the formula for the present value of a growing perpetuity.
B. It is the formula for the present value of an ordinary annuity.
C. It is the formula for the present value of a growing annuity.
D. It is the formula for the present value of a finite, uneven cash flow stream.

57. A company cannot buy back ___________

A. Part of its ordinary shares.
B. All of its redeemable preference shares.
C. Part of its cumulative preference shares.
D. All of its shares.

58. Which of the following organizations has the ultimate regulatory oversight over
the Nigerian Stock market?
A. Chartered Institute of Stockbrokers.
B. Nigerian Stock Exchange.
C. Central Securities Clearing System.
D. None of the above.

59. In a bear market you are not likely to observe which of the following?
A. High dividend yields as against bond yields.
B. Low earnings multiple.
C. Low price-to-sale ratio.
D. High pricetobook ratio.

60. The dividend discount model (DDM) _____________

A. Ignores capital gains.
B. Incorporates the after-tax value of capital gains.
C. Includes capital gains implicitly.
D. Restricts capital gains to a minimum.
61. Which of the following statements is not correct about bonus issue?
A. It amounts to capitalization of reserves.
B. It represents additional shares issued to an investor free in the proportion of
existing share holding.
C. With a bonus issue, the par value of each stock increases.
D. Bonus issue does not result in cash outflow from the company.

62. Which of the following is not a right of equity shareholders?

A. Right to vote at the AGM of the company.
B. Right to share profit in the form of dividends.
C. Right to receive a copy of the statutory report.
D. Right to have first claim in case of winding up of the company.

63. Which of the following factors can affect stock prices?

A. The national economy.
B. The political situation in the country.
C. Global macroeconomic factors.
D. All of the above.

64. Which of the following is least subject to manipulation?

A. Earnings.
B. Sales.
C. Inventory.
D. Expenses.

65. The required rate of return in a particular country depends on all of the following
except ____________
A. A country-specific risk component.
B. The risk-free rate.
C. The inflation rate.
D. A risk premium.

66. An unquoted company cannot raise additional funds through which of the
following methods?
A. Prospectus issue.
B. Private placement.
C. Rights issue.
D. Retained earnings.

67. The rights of equity shareholders include which of the following?

I. Right to exercise control through voting.
II. Residual right to earnings.
III. Pre-emptive right to maintain proportion of ownership through rights issue.
IV. Priority of claim on the assets of the company.

A. I and III only.

B. II and III only.
C. I, II and III only.
D. All of the above.

Fixed Income Valuation and Analysis (68 - 100)

68. Which of the following provisions that might be found in a bond indenture would
tend to reduce the coupon interest rate?
A. A call provision.
B. No restrictive covenants.
C. A sinking fund provision.
D. Change in bond rating from Aaa to Aa.

69. The refunding provision of an indenture allows bonds to be retired unless

A. They are replaced with a lower coupon bond issue.
B. The remaining time to maturity is less than five years.
C. The remaining time to maturity is greater than five years.
D. The stated time period in the indenture has not passed.

70. Which of the following statements is not true regarding bond ratings?
A. The ratings assigned are meant to indicate the probability of default for the bo
nd issuer.
B. The bonds assigned one of the top four rating classes are considered
investment grade bonds.
C. Once a rating is assigned to an issue it cannot be changed for the first two
years after which it is reviewed on a regular basis.
D. Bonds rated BB and below are referred to as high yield or "junk" bonds.

71. Which of the following bonds will have the longest duration?
A. 15-year maturity and a 12% coupon.
B. 20-year maturity and an 8% coupon.
C. 20-year maturity and a 12% coupon.
D. 10-year maturity and a 15% coupon.

72. When a fixed income security is being traded at the price above its face value it
is trading _____________
A. At a discount.
B. At par.
C. At a premium.
D. Flat.

73. A security that has a coupon that is periodically adjusted is a _____________

A. Variable note.
B. Adjustable coupon note.
C. Money market certificate.
D. Deep discount bond.

74. Bond ratings are positively related to _______________

A. Leverage.
B. Size.
C. Type of business.
D. All of the above.

75. Revenue bonds are _______________

A. Treasury bonds backed by the full faith and credit of the issuer.
B. Treasury bonds backed by income generated form specific projects.
C. Municipal bonds backed by the full faith and credit of the issuer.
D. Municipal bonds backed by income generated from specific projects.

76. The best way for an investor to lock in to high interest rates would be to purchase
a bond that has a ___________coupon and a _______________term to maturity.
A. Low, long.
B. High, short.
C. High, long.
D. Zero, very long.
77. If you expected interest rates to rise, you would prefer to own bonds with
A. Short maturities and low coupons.
B. Long maturities and high coupons.
C. Long maturities and low coupons.
D. Short maturities and high coupons.

78. According to the liquidity preference hypothesis, yield curves generally slope
upward because ______________
A. Investors prefer short maturity obligations to long maturity obligations.
B. Investors prefer long maturity obligations to short maturity obligations.
C. Investors prefer less volatile long maturity obligations.
D. Investors prefer more volatile short maturity obligations.

79. Bond investors can avoid the risk that interest rates will rise and drive bond
prices down by ______________
A. Buying zero coupon bonds.
B. Buying treasury bonds.
C. Holding bonds over one year.
D. Holding bonds till maturity.

80. Which of the following is a reason Nigerian investors would invest in foreign
A. To gain diversification.
B. Potentially higher returns than Nigerian bonds.
C. Lower transactions costs and taxes.
D. All of the above.

81. Serial bonds _______________

A. Mature over a series of date.
B. Cannot have sinking funds.
C. Are also called bullet bond.
D. All of the above.

82. A Nigerian government bond has a coupon rate of 5%, face value of N100 and
maturing in five years. The interest payments are made annually. What is the
price of the bond (in Naira) if the yield to maturity is 3.5%?
A. 100
B. 106.77
C. 106.33
D. None of the above.

83. Which of the following is considered to have the biggest impact on bond yields?
A. Economic growth.
B. Business cycles.
C. Inflation.
D. CBNs actions.

84. The term structure of interest rates is also known as the ______________
A. Yield to maturity.
B. Probability distribution.
C. Yield differential.
D. Yield curve.
85. Under the expectations theory, investors expecting interest rates to rise will
A. Invest more now in short term bonds rather than in long term bonds.
B. Invest more now in long term bonds rather than in short term bonds.
C. Invest more now in treasury bonds rather than in corporate bonds.
D. Invest more now in corporate bonds rather than in Treasury bonds.

86. Which of the following is not a reason for a yield spread?

A. Differences in call features.
B. Differences in coupon rates.
C. Differences in maturity
D. Differences in quality.

87. If the 3-year spot rate is 10.5% and the 2-year spot rate is 10%, what is the
one-year forward rate of interest two years from now?
A. 3.7%
B. 9.5%
C. 11.5%
D. None of the above.

88. Which of the following is not a passive bond strategy?

A. An immunization strategy.
B. A bond swap strategy.
C. A buy and hold strategy.
D. An indexing strategy.

89. A portfolio is said to be immunized if _______________

A. The present value of the cashflows equals the principal.
B. The duration of the portfolio is equal to the term.
C. The present value of the cashflows is greater than the principal.
D. The duration of the portfolio is equal to the investment horizon.

90. Interest rate risk is composed of _______________

A. Market risk and default risk.
B. Price risk and credit risk.
C. Price risk and reinvestment risk.
D. Default risk and money risk.

91. A major advantage of bond index funds is their _________________

A. Higher performance than regular bond funds.
B. Ability to shelter income from taxes.
C. Relatively low expense ratios.
D. All of the above are true,

92. A bond issued and supported only by the general credit standing of the issuing
corporation is called a(an) _______________
A. Debenture.
B. Indenture.
C. Term bond.
D. Serial bond.

93. Which of the following statements is not true?

A. Every bond has a face amount.
B. Every bond has a maturity date.
C. Every bond has a bond rate of interest.
D. Every bond is a coupon bond.
94. Which of the following is a disadvantage of bonds to the issuer?
A. Bonds provide long time finance.
B. Interest on bonds is tax deductible.
C. Bonds can increase finance risk.
D. Bonds do not affect shareholders control.

95. Which type of bond gives the issuing corporation the option of retiring the bond,
at a predetermined price, prior to the maturity date of the bond?
A. Convertible bond.
B. Serial bond.
C. Secured bond.
D. Callable bond.

96. Bonds with relatively high risk of default are called ______________
A. Brady bonds.
B. Junk bonds.
C. Zero coupon bonds.
D. Investment grade bonds.

97. When the demand for bonds __________ or the supply of bonds _________
bond prices fall.
A. Increases; increases.
B. Increases; decreases.
C. Decreases; decreases.
D. Decreases; increases.

98. The duration of a ten-year, 10 percent coupon bond when the interest rate is 10
percent is 6.76 years. What happens to the price of the bond if the interest rate
falls to 8 percent?
A. It rises 20 percent.
B. It rises 12.3 percent.
C. It falls 20 percent.
D. It falls 12.3 percent.

99. The current yield on a coupon bond is the bonds ___________ divided by its
A. Annual coupon payment; price.
B. Annual coupon payment; face value.
C. Annual return; price.
D. Annual return; face value.

100. Which of the following is least likely a provision for the early retirement of debt by
the issuer?
A. A call option.
B. A sinking fund.
C. A conversion option.
D. All of the above.

Total = 100 marks