CBS Corporate Finance & Investment 3 — Questions and Answers
Question 1: A project requires an initial investment of $200,000 and generates $50,000 annual cash flows for 5 years. What is the payback period?
- 3 years
- 4 years (Correct answer)
- 5 years
- 2.5 years
Correct answer: 4 years
Payback = Initial investment / Annual cash flow = $200,000 / $50,000 = 4 years.
Question 2: Which financial metric measures how efficiently a company uses its assets to generate earnings?
- Debt ratio
- Return on Assets (ROA) (Correct answer)
- Price-to-Earnings ratio
- Current ratio
Correct answer: Return on Assets (ROA)
ROA = Net income / Total assets, showing how effectively assets generate profit.
Question 3: What is the primary purpose of a leveraged buyout (LBO)?
- To issue new shares to raise equity capital
- To acquire a company using mostly borrowed funds (Correct answer)
- To hedge currency risk in foreign investments
- To consolidate multiple subsidiaries into one entity
Correct answer: To acquire a company using mostly borrowed funds
An LBO uses significant debt financing to acquire a company, with the acquired firm's assets often serving as collateral.
Question 4: Beta of 1.2 for a stock means the stock is expected to:
- Decline 1.2% when the market rises 1%
- Rise 1.2% for every 1% move in the market (Correct answer)
- Pay a 1.2% annual dividend
- Have 1.2 times the average P/E ratio
Correct answer: Rise 1.2% for every 1% move in the market
A beta above 1 means the stock is more volatile than the market; a beta of 1.2 implies 1.2% movement per 1% market movement.
Question 5: Which financial statement best shows a company's ability to meet short-term obligations?
- Income statement
- Statement of retained earnings
- Balance sheet (Correct answer)
- Cash flow statement
Correct answer: Balance sheet
The balance sheet displays current assets and current liabilities, enabling liquidity analysis.
Question 6: Modigliani-Miller Theorem (without taxes) states that a firm's value is:
- Maximized when debt financing equals equity financing
- Dependent on dividend policy
- Independent of its capital structure (Correct answer)
- Determined solely by its P/E ratio
Correct answer: Independent of its capital structure
In a perfect market without taxes, M&M states that capital structure does not affect firm value.
Question 7: A company's WACC is 10% and a project's IRR is 8%. The project should be:
- Accepted because IRR is positive
- Rejected because IRR is below WACC (Correct answer)
- Accepted if the payback period is under 3 years
- Deferred until WACC drops below 8%
Correct answer: Rejected because IRR is below WACC
When IRR falls below WACC, the project destroys value and should be rejected.
CBS Corporate Finance & Investment 3
A project requires an initial investment of $200,000 and generates $50,000 annual cash flows for 5 years.
What is the payback period?