FIA Corporate Finance Fundamentals 2 — Questions and Answers
Question 1: A company has EBIT of $500,000, interest expense of $50,000, and a tax rate of 30%. What is the net income?
- $315,000 (Correct answer)
- $350,000
- $450,000
- $500,000
Correct answer: $315,000
Net income = (EBIT - Interest) × (1 - Tax rate) = ($500,000 - $50,000) × 0.70 = $315,000.
Question 2: Which capital structure theory argues that taxes and bankruptcy costs create an optimal debt level?
- Modigliani-Miller Theorem
- Trade-Off Theory (Correct answer)
- Pecking Order Theory
- Agency Cost Theory
Correct answer: Trade-Off Theory
Trade-Off Theory holds that firms balance the tax shield of debt against rising financial distress costs to find an optimal capital structure.
Question 3: A project requires an initial investment of $200,000 and generates annual cash flows of $50,000 for 6 years. What is the payback period?
- 3 years
- 4 years (Correct answer)
- 5 years
- 6 years
Correct answer: 4 years
Payback period = Initial investment ÷ Annual cash flow = $200,000 ÷ $50,000 = 4 years.
Question 4: Which of the following best describes the concept of operating leverage?
- The ratio of debt to equity in a firm's capital structure
- The sensitivity of EBIT to changes in sales revenue (Correct answer)
- The use of short-term borrowing to fund long-term assets
- The degree to which a firm uses fixed financial costs
Correct answer: The sensitivity of EBIT to changes in sales revenue
Operating leverage measures how a given change in sales amplifies changes in EBIT, driven by fixed versus variable cost structure.
Question 5: A firm's stock currently pays a dividend of $2.00 and dividends are expected to grow at 5% per year. If the required return is 10%, what is the stock's intrinsic value?
- $20.00
- $40.00
- $42.00 (Correct answer)
- $44.00
Correct answer: $42.00
Gordon Growth Model: P = D1 ÷ (r - g) = ($2.00 × 1.05) ÷ (0.10 - 0.05) = $2.10 ÷ 0.05 = $42.00.
Question 6: In a leveraged buyout (LBO), the primary source of repaying acquisition debt is:
- Proceeds from issuing new equity
- Cash flows generated by the acquired company (Correct answer)
- Asset liquidation of the acquiring firm
- Government subsidies
Correct answer: Cash flows generated by the acquired company
LBOs rely on the target company's own operating cash flows to service and repay the acquisition debt.
Question 7: Which ratio measures a company's ability to cover interest payments with operating earnings?
- Current ratio
- Debt-to-equity ratio
- Interest coverage ratio (Correct answer)
- Return on assets
Correct answer: Interest coverage ratio
The interest coverage ratio (EBIT ÷ Interest expense) indicates how many times a company can cover its interest obligations from operating income.
FIA Corporate Finance Fundamentals 2
A company has EBIT of $500,000, interest expense of $50,000, and a tax rate of 30%.
What is the net income?