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Questions and Answers
What is the primary goal of corporate finance?
What is the primary goal of corporate finance?
Which sub-discipline of corporate finance focuses on setting criteria for investment funding?
Which sub-discipline of corporate finance focuses on setting criteria for investment funding?
What does working capital management primarily deal with?
What does working capital management primarily deal with?
Which historical entity is recognized as the first publicly listed company to pay regular dividends?
Which historical entity is recognized as the first publicly listed company to pay regular dividends?
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What aspect of corporate finance is associated with investment banking?
What aspect of corporate finance is associated with investment banking?
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How does financial management differ from financial accounting?
How does financial management differ from financial accounting?
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Which of the following is NOT a focus of corporate finance?
Which of the following is NOT a focus of corporate finance?
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Which region is credited with the early development of corporate finance in the pre-industrial world?
Which region is credited with the early development of corporate finance in the pre-industrial world?
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What is working capital primarily used for within an organization?
What is working capital primarily used for within an organization?
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How is working capital measured?
How is working capital measured?
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Which of the following is NOT a goal of working capital management?
Which of the following is NOT a goal of working capital management?
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What distinguishes working capital management from capital budgeting?
What distinguishes working capital management from capital budgeting?
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Which of the following does NOT fall under the typical current assets managed in working capital?
Which of the following does NOT fall under the typical current assets managed in working capital?
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The term 'corporate finance' is commonly associated with which of the following activities in the United States?
The term 'corporate finance' is commonly associated with which of the following activities in the United States?
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Which of the following risks is NOT typically measured in financial risk management?
Which of the following risks is NOT typically measured in financial risk management?
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What does working capital management primarily aim to improve?
What does working capital management primarily aim to improve?
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What is often more relevant in working capital management compared to capital budgeting?
What is often more relevant in working capital management compared to capital budgeting?
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Which characteristic differentiates the decisions made in working capital management?
Which characteristic differentiates the decisions made in working capital management?
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What is a primary characteristic of preferred stock?
What is a primary characteristic of preferred stock?
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What does the Trade-Off Theory explain?
What does the Trade-Off Theory explain?
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What does capital budgeting mainly focus on?
What does capital budgeting mainly focus on?
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What is the minimum acceptable return on an investment known as?
What is the minimum acceptable return on an investment known as?
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Which of the following theories suggests that firms prefer internal financing over external financing?
Which of the following theories suggests that firms prefer internal financing over external financing?
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What is a key factor in determining the Net Present Value (NPV) of a project?
What is a key factor in determining the Net Present Value (NPV) of a project?
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What does a higher discount rate indicate about a project?
What does a higher discount rate indicate about a project?
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Which measure directly considers economic profit as an alternative to NPV?
Which measure directly considers economic profit as an alternative to NPV?
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Which of the following is an assumption of the Market Timing Hypothesis?
Which of the following is an assumption of the Market Timing Hypothesis?
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What is a primary concern when applying a discount rate to a project?
What is a primary concern when applying a discount rate to a project?
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In the context of capital budgeting, what does DCF stand for?
In the context of capital budgeting, what does DCF stand for?
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Preferred stockholders typically have which rights compared to common stockholders?
Preferred stockholders typically have which rights compared to common stockholders?
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Which capital budgeting measure includes assessing the time it takes to recoup the original investment?
Which capital budgeting measure includes assessing the time it takes to recoup the original investment?
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In analyzing an investment's risk, which metric is often considered?
In analyzing an investment's risk, which metric is often considered?
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What is the primary goal of financial management?
What is the primary goal of financial management?
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Which factor is considered when choosing between investment projects?
Which factor is considered when choosing between investment projects?
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What is capital budgeting concerned with?
What is capital budgeting concerned with?
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When might a company choose to pay out dividends?
When might a company choose to pay out dividends?
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What form of financing combines properties of both common stock and debt instruments?
What form of financing combines properties of both common stock and debt instruments?
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Which of the following is NOT a source of financing for corporations?
Which of the following is NOT a source of financing for corporations?
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What is meant by 'sinking fund provisions' in corporate finance?
What is meant by 'sinking fund provisions' in corporate finance?
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Why might corporations issue callable bonds?
Why might corporations issue callable bonds?
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What is a characteristic of firms that are considered growth companies?
What is a characteristic of firms that are considered growth companies?
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Why is the financing mix important for a corporation?
Why is the financing mix important for a corporation?
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What is a typical expectation of investors who buy shares in a corporation?
What is a typical expectation of investors who buy shares in a corporation?
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What is the primary consideration for a company's dividend policy?
What is the primary consideration for a company's dividend policy?
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What kind of projects should management typically prioritize for investment?
What kind of projects should management typically prioritize for investment?
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What is the effect of a company reaching maturity within its industry?
What is the effect of a company reaching maturity within its industry?
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What is the implication of the Modigliani–Miller theorem regarding dividend policy?
What is the implication of the Modigliani–Miller theorem regarding dividend policy?
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What do shareholders of growth stocks generally prefer regarding excess cash?
What do shareholders of growth stocks generally prefer regarding excess cash?
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Which of the following models suggests that dividends should only be paid if retained capital earns a higher return?
Which of the following models suggests that dividends should only be paid if retained capital earns a higher return?
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What is the primary goal of corporate finance?
What is the primary goal of corporate finance?
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What does working capital management refer to?
What does working capital management refer to?
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Which scenario would prompt management to pay cash dividends?
Which scenario would prompt management to pay cash dividends?
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What effect might stable or smooth dividend payouts have on a company's share price?
What effect might stable or smooth dividend payouts have on a company's share price?
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What is the major benefit of a share buyback program?
What is the major benefit of a share buyback program?
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What might lead management to prefer retaining earnings over paying dividends?
What might lead management to prefer retaining earnings over paying dividends?
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What is a major reason for companies to choose stock buybacks instead of dividends?
What is a major reason for companies to choose stock buybacks instead of dividends?
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What does the Clientele effect refer to in relation to dividend policies?
What does the Clientele effect refer to in relation to dividend policies?
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Which theory supports the idea that a firm's capital structure can be manipulated through dividend policies?
Which theory supports the idea that a firm's capital structure can be manipulated through dividend policies?
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Why might some companies choose to issue dividends in stock rather than cash?
Why might some companies choose to issue dividends in stock rather than cash?
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What does sensitivity analysis determine in the context of project NPV?
What does sensitivity analysis determine in the context of project NPV?
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In a scenario-based forecast, what comprises a scenario?
In a scenario-based forecast, what comprises a scenario?
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What is the purpose of constructing stochastic financial models?
What is the purpose of constructing stochastic financial models?
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Which method is most commonly used for stochastic modeling in project NPV analysis?
Which method is most commonly used for stochastic modeling in project NPV analysis?
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What aspect of project valuation does the Monte Carlo simulation help visualize?
What aspect of project valuation does the Monte Carlo simulation help visualize?
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How does scenario-based analysis differ from sensitivity analysis?
How does scenario-based analysis differ from sensitivity analysis?
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What does probability-weighted average NPV represent?
What does probability-weighted average NPV represent?
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What limitation do traditional sensitivity and scenario analyses share?
What limitation do traditional sensitivity and scenario analyses share?
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Which statement accurately describes the adjustment of NPV when considering project uncertainty?
Which statement accurately describes the adjustment of NPV when considering project uncertainty?
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What type of variables are heavily impacted by uncertainty in Monte Carlo simulations?
What type of variables are heavily impacted by uncertainty in Monte Carlo simulations?
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What does a histogram generated by a Monte Carlo simulation reveal?
What does a histogram generated by a Monte Carlo simulation reveal?
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Which tool can be used alongside spreadsheet-based DCF models for risk analysis?
Which tool can be used alongside spreadsheet-based DCF models for risk analysis?
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What is a primary feature of the flexible and staged investment approach?
What is a primary feature of the flexible and staged investment approach?
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Why may management adjust cash flows during project valuation?
Why may management adjust cash flows during project valuation?
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Study Notes
Corporate Finance Basics
- Corporate finance deals with funding sources, capital structure, shareholder value maximization, and resource allocation.
- Two primary sub-disciplines: capital budgeting and working capital management.
- Capital budgeting focuses on choosing value-adding projects for investment and determining the financing mix (equity or debt).
- Working capital management involves managing short-term assets and liabilities, such as cash, inventory, and short-term borrowing and lending.
- Investment banks play a crucial role in evaluating a company's financial needs and raising capital to match those needs.
History of Corporate Finance
- The roots of corporate finance can be traced back to the 15th century in Italian city-states and the Low Countries.
- The Dutch East India Company (VOC) was the first publicly listed company paying regular dividends and the first recorded joint-stock company with fixed capital stock.
- Public markets for investment securities emerged in the Dutch Republic during the 17th century, further shaping corporate finance.
- London became a global center for corporate finance in the early 1800s, leading to innovations in lending and investment.
- The 20th century saw the rise of managerial capitalism and common stock finance, with share capital being raised through listings.
- Modern corporate finance, along with investment management, developed rapidly in the second half of the 20th century, particularly in the US and UK.
Maximalizing Shareholder Value
- The primary goal of financial management is to maximize or increase shareholder value.
- Managers achieve this by balancing investments in projects and returning excess cash to shareholders through dividends or share buybacks.
- Capital budgeting plays a crucial role in maximizing firm value by investing in projects with a positive net present value (NPV), while considering relevant discount rates and risk.
- Dividend policy involves distributing surplus cash to shareholders when no growth or expansion is likely, and excess cash exists.
Financing Corporate Investments
- Corporate investments can be financed through internal funds generated by the firm or external funds raised via issuing debt, equity, or hybrid securities.
- The financing mix affects the valuation of the firm and requires careful consideration.
- Debt financing involves borrowing funds, such as bank loans, notes payable, or bonds, and making regular interest payments until the debt matures.
- Equity financing involves selling shares of the company to investors, who expect an upward trend in value over time.
- Preferred stock is a hybrid security with characteristics of both common stock and debt instruments. It typically carries no voting rights but may offer a dividend and priority in dividend payments and liquidation.
The Trade-Off Theory of Capital Structure
- The Trade-Off Theory assumes firms balance the tax benefits of debt with the bankruptcy costs of debt when determining their capital structure.
- Pecking Order Theory suggests firms prioritize internal financing, followed by debt and lastly new equity financing.
- Capital structure substitution theory proposes that management manipulates the capital structure to maximize earnings per share (EPS).
- Right-financing emphasizes finding the right combination of investment objectives, policy framework, institutional structure, financing source, and expenditure framework for optimal value creation.
- Market timing hypothesis argues that firms seek the cheapest financing option, regardless of their existing resources.
Capital Budgeting: Allocating Financial Resources
- Capital budgeting is the process of allocating financial resources for major investments, ensuring they add value to the firm.
- Investments must demonstrate improvements in operating profit and cash flows while considering the impact on the firm's capital structure.
- Projects are typically valued using discounted cash flow (DCF) valuation, selecting the option with the highest net present value (NPV).
- Hurdle rate represents the minimum acceptable return on an investment, considering its riskiness and financing mix.
Capital Budgeting: Analyzing Project Value
- NPV is greatly influenced by the discount rate, making it essential to choose the appropriate hurdle rate.
- Models like CAPM or APT are used to estimate the appropriate discount rate for specific projects, and the weighted average cost of capital (WACC) reflects the selected financing mix.
- Other selection criteria used alongside NPV include: discounted payback period, IRR, Modified IRR, equivalent annuity, capital efficiency, and ROI.
- Economic profit is considered in valuation techniques like residual income valuation, MVA / EVA, and APV.
- Sensitivity analysis examines how project NPV varies with changes in key inputs (assumptions), providing insights into project risk.
- Scenario-based forecasting involves predicting NPV under different economic and company-specific conditions, helping assess project robustness.
- Stochastic modeling uses Monte Carlo simulation to analyze project NPV, considering uncertainties and potential outcomes, providing a more comprehensive view of risk and value.
- Real options valuation acknowledges the flexibility and staged nature of investments, considering all potential payoffs beyond the initial investment decision.
Real Options Valuation
- The "value of flexibility" is the difference between two valuations.
- Decision Tree Analysis (DTA) and real options valuation (ROV) are interchangeable.
Dividend Policy
- Determined by company type and best use of resources.
- Maximizes shareholder value over long-term.
- Cash dividends or stock buybacks are used to return surplus.
- Shareholders of "growth stocks" prefer reinvesting profits.
- Shareholders of value stocks prefer dividends.
- Payout form is determined by tax implications.
- Dividends are value neutral if no tax disadvantages.
- Dividends can reduce firm value if tax disadvantages exist.
- Investors prefer steady and reliable dividends.
- Increasing dividends can signal positive future performance.
Investing and Financing
- Residual dividend policy uses retained profits to fund capital investments.
- Walter model suggests dividends are paid if retained capital earns higher return than investors.
- Management may manipulate capital structure to maximize earnings per share.
Working Capital Management
- Focuses on short-term assets and liabilities to ensure operational fluidity.
- Goal is to service long-term debt, short-term debt, and operational expenses.
- Maximizes firm value when return on capital exceeds cost of capital.
- Measured by current assets minus current liabilities.
- Key considerations are cash flow/liquidity and profitability/return on capital.
Corporate Finance
- Used in the US to describe financial activities and techniques.
- Used in the UK and Commonwealth countries for investment banking activities.
Financial Risk Management
- Focuses on market risk, credit risk, and operational risk.
- Broadens to include enterprise risk management and strategic objectives.
- Links financial exposures and opportunities to risk appetite and share price.
- Overlaps "Corporate Finance" in large firms, with the CRO consulted on strategic decisions.
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Description
Test your knowledge of corporate finance fundamentals, including capital structure, shareholder value, and resource allocation. This quiz covers critical concepts in capital budgeting and working capital management, along with the historical context of corporate finance.
