US CMA Part 2 · Chapter 4
Corporate finance: working capital, raising capital, mergers and international finance MCQs with Answers
15 multiple-choice questions on Corporate finance: working capital, raising capital, mergers and international finance for US CMA Part 2 Strategic Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A supplier offers terms of 2/10, net 40. Using a 365-day year and simple interest, what is the approximate annual cost of NOT taking the discount and paying on day 40?
- A) 24.33%
- B) 18.37%
- C) 24.83%
- D) 18.62%
Show answer & explanation
Answer: C) 24.83%
Annual cost = [discount % / (100% - discount %)] x [365 / (total period - discount period)] = (2 / 98) x (365 / 30) = 0.020408 x 12.1667 = 24.83%. Forgoing the discount is equivalent to borrowing $98 for 30 days at a cost of $2, which is very expensive financing.
Question 2
Fairmont Corp. borrows $500,000 for one year at a stated rate of 8%. The bank requires a 10% compensating balance in a non-interest-bearing account; Fairmont does not otherwise keep cash with the bank. What is the effective annual interest rate?
- A) 8.00%
- B) 8.89%
- C) 8.70%
- D) 8.80%
Show answer & explanation
Answer: B) 8.89%
Interest = $500,000 x 8% = $40,000. Usable funds = $500,000 x (1 - 10%) = $450,000. Effective rate = $40,000 / $450,000 = 8.89%. 8.70% would be the effective rate of a discount loan with no compensating balance.
Question 3
A lockbox system would reduce Granger Corp.'s collection float by 2 days. Average daily collections are $150,000, freed funds can earn 6% per year, and the bank charges an annual fee of $12,000. What is the net annual benefit of the lockbox?
- A) $18,000
- B) $6,000
- C) -$3,000
- D) $288,000
Show answer & explanation
Answer: B) $6,000
Funds released = 2 days x $150,000 = $300,000. Annual earnings on released funds = $300,000 x 6% = $18,000. Net benefit = $18,000 - $12,000 = $6,000. The released cash is a one-time balance, so only the return on it is an annual benefit.
Question 4
Hollis Distributors sells 36,000 units of a product per year. Each order costs $60 to place and the annual carrying cost is $3.00 per unit. What is the economic order quantity?
- A) 60 units
- B) 1,200 units
- C) 1,440 units
- D) 849 units
Show answer & explanation
Answer: B) 1,200 units
EOQ = square root of (2 x annual demand x order cost / carrying cost per unit) = square root of (2 x 36,000 x 60 / 3) = square root of 1,440,000 = 1,200 units. At the EOQ, annual ordering cost (30 orders x $60 = $1,800) equals annual carrying cost (1,200/2 x $3 = $1,800).
Question 5
Ingram Parts uses 120 units of a component per day. Supplier lead time is 6 days and the company holds a safety stock of 300 units. At what inventory level should it reorder?
- A) 1,020 units
- B) 720 units
- C) 420 units
- D) 1,140 units
Show answer & explanation
Answer: A) 1,020 units
Reorder point = (daily usage x lead time) + safety stock = (120 x 6) + 300 = 720 + 300 = 1,020 units. Omitting the safety stock (720 units) would leave no buffer against delays or higher-than-expected usage.
Question 6
A treasurer is choosing a short-term investment for temporary excess cash that may be needed at short notice. Which characteristics are most important?
- A) Tax-free income with long maturity, such as 30-year municipal bonds
- B) High expected return and long maturity, such as 20-year corporate bonds
- C) Capital growth potential, such as common stock of growth companies
- D) High liquidity and low default risk, such as US Treasury bills
Show answer & explanation
Answer: D) High liquidity and low default risk, such as US Treasury bills
Marketable securities held as a cash substitute should be safe and quickly convertible to cash with little price risk. Treasury bills and similar money market instruments meet these criteria. Long-maturity bonds and equities expose the company to interest rate and market price risk that is inappropriate for temporary cash balances.
Question 7
Jarvis Furnishings is considering relaxing its credit standards. Annual sales would increase by $400,000, its contribution margin ratio is 30%, and bad debts on the additional sales are expected to be 3%. Average investment in receivables would rise by $60,000, and the required return on that investment is 10%. What is the expected increase in annual pre-tax profit?
- A) $120,000
- B) $108,000
- C) $48,000
- D) $102,000
Show answer & explanation
Answer: D) $102,000
Additional contribution = $400,000 x 30% = $120,000. Less bad debts = $400,000 x 3% = $12,000. Less financing cost of extra receivables = $60,000 x 10% = $6,000. Net increase = $120,000 - $12,000 - $6,000 = $102,000. The full $60,000 is an investment, not an annual cost; only its carrying cost is deducted.
Question 8
In a firm commitment underwriting of an initial public offering, which party bears the risk that the shares cannot be sold at the offering price?
- A) The investment banker (underwriter), which buys the entire issue from the company
- B) The Securities and Exchange Commission, which approved the registration
- C) The company's existing shareholders, who must buy any unsold shares
- D) The issuing company, which receives only the proceeds of shares actually sold
Show answer & explanation
Answer: A) The investment banker (underwriter), which buys the entire issue from the company
In a firm commitment underwriting the investment bank buys the whole issue at an agreed price and resells it to the public, so it bears the risk of unsold shares or a fall in price. In a best-efforts arrangement the issuer bears that risk. The SEC reviews disclosure but does not guarantee the success of an offering.
Question 9
Compared with a public offering, which is a typical advantage of a private placement of debt with a small number of institutional investors?
- A) Wider ownership of the securities among retail investors
- B) Lower issuance costs and faster execution because SEC registration is not required
- C) Fewer restrictive covenants because institutional lenders monitor less closely
- D) A lower interest rate because the securities are highly liquid
Show answer & explanation
Answer: B) Lower issuance costs and faster execution because SEC registration is not required
Private placements avoid full SEC registration, so issuance costs are lower and the deal can be completed quickly, and terms can be negotiated directly. In exchange, privately placed securities are less liquid, so investors usually demand a slightly higher yield, and institutional lenders often negotiate tailored covenants.
Question 10
According to the semi-strong form of the efficient markets hypothesis, which of the following should NOT enable an investor to earn consistent abnormal returns?
- A) Being the first to act on information before it is released to the public
- B) Holding a diversified portfolio that bears more systematic risk than the market
- C) Analyzing a company's published financial statements and press releases
- D) Trading on material non-public information obtained from a company director
Show answer & explanation
Answer: C) Analyzing a company's published financial statements and press releases
The semi-strong form states that prices reflect all publicly available information, including published financial statements, so fundamental analysis of public data should not produce consistent abnormal returns. Inside (non-public) information can still generate abnormal returns unless markets are strong-form efficient. Bearing more systematic risk earns a higher expected return, but that is a normal, not an abnormal, return.
Question 11
Kendrick Corp. (stand-alone value $400 million) plans to acquire Lowell Inc. (stand-alone value $120 million). The combined company is expected to be worth $560 million. Kendrick will pay $150 million in cash for Lowell. What is the NPV of the acquisition to Kendrick's shareholders?
- A) $10 million
- B) $40 million
- C) $50 million
- D) $30 million
Show answer & explanation
Answer: A) $10 million
Synergy = combined value - stand-alone values = $560m - $400m - $120m = $40m. Premium paid = price - target value = $150m - $120m = $30m. NPV to acquirer = synergy - premium = $40m - $30m = $10m. Equivalently, $560m - $150m cash - $400m = $10m. Lowell's shareholders capture the $30m premium.
Question 12
A target company's board adopts a plan under which, if any bidder acquires more than 15% of its shares, all other shareholders may buy additional shares at a deep discount. This takeover defense is known as a:
- A) Greenmail payment
- B) Poison pill (shareholder rights plan)
- C) Golden parachute
- D) White knight
Show answer & explanation
Answer: B) Poison pill (shareholder rights plan)
A poison pill dilutes a hostile bidder by allowing other shareholders to buy shares cheaply once a threshold is crossed, making the takeover much more expensive. A golden parachute is a generous severance package for executives, a white knight is a friendlier alternative acquirer, and greenmail is repurchasing the raider's shares at a premium.
Question 13
A conglomerate creates a new independent company from one of its divisions and distributes the new company's shares to its existing shareholders pro rata, without receiving cash. This is called a:
- A) Spin-off
- B) Horizontal merger
- C) Leveraged buyout
- D) Carve-out (equity carve-out)
Show answer & explanation
Answer: A) Spin-off
In a spin-off, shares of the new company are distributed to the parent's shareholders with no cash raised. In an equity carve-out, the parent sells a minority stake in the subsidiary to the public for cash. A leveraged buyout is an acquisition financed mainly with debt, and a horizontal merger combines competitors in the same line of business.
Question 14
The spot exchange rate is $1.10 per euro. One-year interest rates are 5% in the United States and 3% in the eurozone. According to interest rate parity, what should the one-year forward rate be (rounded to four decimals)?
- A) $1.1220 per euro
- B) $1.1000 per euro
- C) $1.0790 per euro
- D) $1.1214 per euro
Show answer & explanation
Answer: D) $1.1214 per euro
Interest rate parity: forward ($/euro) = spot x (1 + US rate) / (1 + euro rate) = 1.10 x 1.05 / 1.03 = 1.1214. The currency with the higher interest rate (the dollar) trades at a forward discount, so more dollars are needed per euro in the forward market. Inverting the interest rates gives 1.0790.
Question 15
A US exporter will receive EUR 500,000 from a German customer in 90 days. Which action hedges the exporter's transaction exposure?
- A) Buy a 90-day call option on EUR 500,000
- B) Enter into a 90-day forward contract to buy EUR 500,000 with US dollars
- C) Deposit US dollars in a euro-denominated bank account today
- D) Enter into a 90-day forward contract to sell EUR 500,000 for US dollars
Show answer & explanation
Answer: D) Enter into a 90-day forward contract to sell EUR 500,000 for US dollars
The exporter has a euro receivable and loses if the euro weakens. Selling the euros forward locks in the dollar amount it will receive. Buying euros forward or buying a euro call option would add to, not offset, its long euro position. A put option on euros, or borrowing euros now and converting them to dollars (a money market hedge), would also be valid hedges.