FIA Corporate Finance Fundamentals 3 — Questions and Answers
Question 1: A company has total assets of $1,000,000, total liabilities of $600,000, and net income of $80,000. What is the return on equity (ROE)?
- 8%
- 13.3%
- 20% (Correct answer)
- 25%
Correct answer: 20%
ROE = Net Income ÷ Shareholders' Equity = $80,000 ÷ ($1,000,000 - $600,000) = $80,000 ÷ $400,000 = 20%.
Question 2: Which of the following is NOT a component of the DuPont analysis of ROE?
- Net profit margin
- Asset turnover
- Equity multiplier
- Dividend payout ratio (Correct answer)
Correct answer: Dividend payout ratio
DuPont ROE = Net Profit Margin × Asset Turnover × Equity Multiplier; dividend payout ratio is not a DuPont component.
Question 3: When calculating free cash flow to the firm (FCFF), which item is added back to net income?
- Dividends paid
- Depreciation and amortization (Correct answer)
- Interest received
- Income tax expense
Correct answer: Depreciation and amortization
Depreciation and amortization are non-cash charges added back to net income when computing FCFF.
Question 4: A bond with a face value of $1,000 pays a 6% annual coupon and matures in 5 years. If the market yield is 8%, the bond trades at:
- A premium
- Par value
- A discount (Correct answer)
- Cannot be determined
Correct answer: A discount
When the market yield exceeds the coupon rate, the bond trades below face value (at a discount).
Question 5: Which of the following best describes agency costs in corporate finance?
- Costs incurred when hiring external consultants
- Costs arising from conflicts of interest between principals and agents (Correct answer)
- Transaction costs of issuing new securities
- Legal fees for corporate restructuring
Correct answer: Costs arising from conflicts of interest between principals and agents
Agency costs arise from the misalignment of interests between shareholders (principals) and managers (agents), including monitoring and bonding costs.
Question 6: A company with a beta of 1.5, a risk-free rate of 3%, and a market risk premium of 6% has a cost of equity of:
- 7.5%
- 9%
- 12% (Correct answer)
- 12.5%
Correct answer: 12%
CAPM: Cost of equity = 3% + 1.5 × 6% = 3% + 9% = 12%.
Question 7: Which of the following is true about the internal rate of return (IRR) rule?
- Accept a project if its IRR is less than WACC
- Accept a project if its IRR exceeds the hurdle rate (Correct answer)
- IRR should always be used instead of NPV
- IRR is unaffected by the timing of cash flows
Correct answer: Accept a project if its IRR exceeds the hurdle rate
Under the IRR rule, a project is acceptable when its IRR exceeds the required hurdle rate (usually WACC), indicating value creation.
FIA Corporate Finance Fundamentals 3
A company has total assets of $1,000,000, total liabilities of $600,000, and net income of $80,000.
What is the return on equity (ROE)?