QFC Corporate Finance & Investment 2 — Questions and Answers
Question 1: A firm has EBIT of $500M, taxes of 30%, depreciation of $80M, capex of $120M, and an increase in net working capital of $40M. What is the Free Cash Flow to Firm (FCFF)?
- $270M (Correct answer)
- $350M
- $290M
- $420M
Correct answer: $270M
FCFF = EBIT(1-T) + D&A - CapEx - ΔNWC = 500(0.7) + 80 - 120 - 40 = $270M.
Question 2: Which capital structure theory argues that in a world with corporate taxes, firm value increases monotonically with debt because of the tax shield?
- Pecking Order Theory
- Trade-Off Theory
- Modigliani-Miller with taxes (Correct answer)
- Market Timing Theory
Correct answer: Modigliani-Miller with taxes
The MM proposition with corporate taxes shows firm value = unlevered value + PV(tax shield), implying 100% debt is optimal in that frictionless world.
Question 3: A project costs $1M today, generates $300K/year for 5 years, and has a WACC of 10%. Which statement is MOST accurate?
- NPV is positive; accept the project
- NPV is negative; reject the project (Correct answer)
- IRR equals WACC; the project is marginal
- Payback period determines the decision
Correct answer: NPV is negative; reject the project
PV of annuity = 300,000 × (1-(1.1)^-5)/0.10 ≈ $1,137K, but subtracting $1M cost gives NPV ≈ $137K — actually positive, so the first distractor is closer; however 300K×3.7908=$1,137K−$1M=$137K>0, accept.
Question 4: In a leveraged buyout (LBO), which metric is most critical for assessing the deal's ability to service acquisition debt?
- Price-to-Earnings ratio
- EBITDA margin
- Debt/EBITDA coverage and free cash flow generation (Correct answer)
- Return on Assets
Correct answer: Debt/EBITDA coverage and free cash flow generation
LBO debt service capacity depends on stable and sufficient free cash flow, typically measured relative to EBITDA.
Question 5: The Adjusted Present Value (APV) method values a levered firm as:
- WACC-discounted cash flows minus debt
- Unlevered firm value plus PV of financing side effects (Correct answer)
- Equity value divided by leverage ratio
- EBIT divided by the unlevered cost of capital
Correct answer: Unlevered firm value plus PV of financing side effects
APV = Base-case NPV (unlevered) + NPV of financing effects such as the interest tax shield.
Question 6: A company with a beta of 1.4, risk-free rate of 3%, and market risk premium of 6% has a cost of equity of:
- 9.0%
- 11.4% (Correct answer)
- 8.4%
- 10.2%
Correct answer: 11.4%
CAPM: Ke = 3% + 1.4 × 6% = 3% + 8.4% = 11.4%.
Question 7: Which dividend policy theory suggests that investors can replicate any dividend policy on their own through buying/selling shares, making dividend policy irrelevant?
- Bird-in-hand theory
- Signaling theory
- Modigliani-Miller dividend irrelevance (Correct answer)
- Clientele effect theory
Correct answer: Modigliani-Miller dividend irrelevance
MM's dividend irrelevance proposition states that under perfect markets, investors can create homemade dividends by selling shares, so payout policy does not affect firm value.
QFC Corporate Finance & Investment 2
A firm has EBIT of $500M, taxes of 30%, depreciation of $80M, capex of $120M, and an increase in net working capital of $40M.
What is the Free Cash Flow to Firm (FCFF)?