Question 1

In the Traditional view, at what level of borrowing does the Optimal Capital Structure occur?

Accepted Answer

A)  Shareholders' marginal demand for risk compensation due to borrowing is just equal to the increased returns from borrowing. 
B)  The cost of common share capital is equal to the cost of borrowing. 
C)  The benefits arising from tax relief due to borrowing are offset by the potential cost of bankruptcy. 
D)  Shareholders are no longer indifferent to the risks associated with borrowing. 
E)  There is any borrowing as shareholders always demand risk compensation equal to the increased returns from borrowing. 
A)  Shareholders' marginal demand for risk compensation due to borrowing is just equal to the increased returns from borrowing. 
B)  The cost of common share capital is equal to the cost of borrowing. 
C)  The benefits arising from tax relief due to borrowing are offset by the potential cost of bankruptcy. 
D)  Shareholders are no longer indifferent to the risks associated with borrowing. 
E)  There is any borrowing as shareholders always demand risk compensation equal to the increased returns from borrowing. D

Question 2

What is the cost of shares to the business is equivalent to?

Accepted Answer

A)  The average year-over-year percent increase in share price. 
B)  The NPV of the return to the company from its investments. 
C)  The bank rate grossed up by a risk premium and the rate of inflation. 
D)  The IRR used to evaluate the company's investment projects. 
E)  The NPV of the future share prices. 
A)  The average year-over-year percent increase in share price. 
B)  The NPV of the return to the company from its investments. 
C)  The bank rate grossed up by a risk premium and the rate of inflation. 
D)  The IRR used to evaluate the company's investment projects. 
E)  The NPV of the future share prices. D

Question 3

The returns from Guardian Grocers Ltd. are approximately three-quarters as volatile as that of the market as a whole. If 90-day Treasury bills are trading at 4.2%, the expected return to the market over the next period is 7%, what is the required rate of return by shareholders for Guardian Grocers Ltd.?

Accepted Answer

A)  4.5 
B)  5.2 
C)  6.3 
D)  7.9 
E)  9.1 
A)  4.5 
B)  5.2 
C)  6.3 
D)  7.9 
E)  9.1 C

Question 4

JY Electronics has EBIT of $35 million, interest expense of $4.5 million, a tax rate of 24% and 15 million common shares outstanding. It is looking for $22 million in long-term capital to finance a project that will provide an increase to EBIT of $3.5 million each year. It could fund the project by issuing bonds with a coupon rate of 9.1% or issuing 2.2 million shares at $10 each. Ignoring issuing expense, at what level of EBIT is JY Electronics indifferent as to the financing option?

Accepted Answer

A)  $0.64 million 
B)  $20.14 million 
C)  $35.64 million 
D)  $55.15 million 
E)  $107.02 million 
A)  $0.64 million 
B)  $20.14 million 
C)  $35.64 million 
D)  $55.15 million 
E)  $107.02 million

Question 5

Markle Ltd. has issued $7.5 million worth of bonds with an interest rate of 10%, payable annually, and redemption in 10 years. The issue price of the bond is $85 per $100 of nominal value. If Markle's tax rate is 35%, what is the cash flow each year that is associated with this debt?

Accepted Answer

A)  Year 0 has an inflow of $7.5 million. Each of Years 1-19 have an outflow of $637,500 and Year 5 has an outflow of $8.14 million. 
B)  Year 0 has an inflow of $7.5 million. Year 5 has an outflow of $9.94 million. 
C)  Year 0 has an inflow of $6.38 million and Year 5 has an outflow of $11.25 million. 
D)  Year 0 has an inflow of $6.38 million. Each of Years 2-9 has an outflow of $487,500. Year 10 is an outflow of $7.99 million. 
E)  Year 0 has an inflow of $6.38 million. Each of Years 1-9 has an outflow of $750,000. Year 10 has an outflow of $8.25 million. 
A)  Year 0 has an inflow of $7.5 million. Each of Years 1-19 have an outflow of $637,500 and Year 5 has an outflow of $8.14 million. 
B)  Year 0 has an inflow of $7.5 million. Year 5 has an outflow of $9.94 million. 
C)  Year 0 has an inflow of $6.38 million and Year 5 has an outflow of $11.25 million. 
D)  Year 0 has an inflow of $6.38 million. Each of Years 2-9 has an outflow of $487,500. Year 10 is an outflow of $7.99 million. 
E)  Year 0 has an inflow of $6.38 million. Each of Years 1-9 has an outflow of $750,000. Year 10 has an outflow of $8.25 million.

Question 6

Intelligent Corp. (IC) pays an annual dividend of $2.00 per share. IC announced it will start to grow the dividend by 15% per year from now on. If IC's shareholders require a 20% return on common shares, what should one share of IC stock sell for?

Accepted Answer

A)  $10.00 
B)  $11.50 
C)  $15.33 
D)  $40.00 
E)  $46.00 
A)  $10.00 
B)  $11.50 
C)  $15.33 
D)  $40.00 
E)  $46.00

Question 7

What is one strategy that a hedge fund uses to maximize shareholder wealth?

Accepted Answer

A)  Investing exclusively in select exchange traded funds (ETFs). 
B)  Using correlation coefficients to create perfectly diversified portfolios. 
C)  Investing in low yield, government securities. 
D)  Investing exclusively in market indexes. 
E)  Levering itself by selling short (shares it does not yet own). 
A)  Investing exclusively in select exchange traded funds (ETFs). 
B)  Using correlation coefficients to create perfectly diversified portfolios. 
C)  Investing in low yield, government securities. 
D)  Investing exclusively in market indexes. 
E)  Levering itself by selling short (shares it does not yet own).

Question 8

A company has 1.5 million 5% preferred shares with a nominal value of $50 and a market capitalization of $91.5 million. What is the cost of capital for the preferred shares?

Accepted Answer

A)  4.1% 
B)  7.5% 
C)  8.2% 
D)  10.0% 
E)  13.7% 
A)  4.1% 
B)  7.5% 
C)  8.2% 
D)  10.0% 
E)  13.7%

Question 9

How can dividends over the entire future life of a business be relevant to a short term investor?

Accepted Answer

A)  The share price when the investor sells should reflect the present value of all future earnings streams of the company. 
B)  The share price when the investor sells should reflect the present value of all future dividends of the company. 
C)  The share price when the investor sells should reflect the present value of all future earnings per share of the company. 
D)  The share price when the investor sells should reflect the after-tax present value of all future earnings of the company. 
E)  The share price when the investor sells should reflect after-tax the present value of all future dividends of the company. 
A)  The share price when the investor sells should reflect the present value of all future earnings streams of the company. 
B)  The share price when the investor sells should reflect the present value of all future dividends of the company. 
C)  The share price when the investor sells should reflect the present value of all future earnings per share of the company. 
D)  The share price when the investor sells should reflect the after-tax present value of all future earnings of the company. 
E)  The share price when the investor sells should reflect after-tax the present value of all future dividends of the company.

Question 10

Intelligent Corp. (IC) has paid an annual dividend of $2.00 per share ever since it was formed ten years ago. Today IC announced it will start to grow the dividend by 15% per year from now on. If IC's shareholders require a 20% return on common shares, by what percentage should IC's share price jump according to the dividend-based approach to share valuation?

Accepted Answer

A)  60% 
B)  120% 
C)  180% 
D)  360% 
E)  480% 
A)  60% 
B)  120% 
C)  180% 
D)  360% 
E)  480%

Question 11

If the risk co-efficient, beta, for McDonald's Corporation is .9, what can be said about the fluctuation of the company's returns?

Accepted Answer

A)  They are similar to, but not as volatile, as the returns from the market as a whole. 
B)  They are nearly non-existent. 
C)  They cannot be calculated without a beta value for the market as a whole. 
D)  They are significantly more volatile than the returns from the market a whole. 
E)  They are similar to, but more volatile, than the returns from the market as a whole. 
A)  They are similar to, but not as volatile, as the returns from the market as a whole. 
B)  They are nearly non-existent. 
C)  They cannot be calculated without a beta value for the market as a whole. 
D)  They are significantly more volatile than the returns from the market a whole. 
E)  They are similar to, but more volatile, than the returns from the market as a whole.

Question 12

Which of the following is an assumption of the Capital Asset Pricing Model?

Accepted Answer

A)  Very few investors hold fully diversified portfolios. 
B)  The relationship between beta and expected returns are seldom linear. 
C)  Returns on specific shares are affected by general market changes only. 
D)  Beta values tend to be unstable over the long term. 
E)  Historical data can be used to predict the future. 
A)  Very few investors hold fully diversified portfolios. 
B)  The relationship between beta and expected returns are seldom linear. 
C)  Returns on specific shares are affected by general market changes only. 
D)  Beta values tend to be unstable over the long term. 
E)  Historical data can be used to predict the future.

Question 13

I-polo International Inc. has a tax rate of 22% and a capital structure that includes five million common shares outstanding at a rate of $26.50 per share. Its expected dividend for next year is $2.25, the result of a constant rate of dividend growth of 2% per year. It has four million bonds with a face value of $1,000, a coupon rate of 9% and selling at a price of $840. What is the weighted average cost of capital (WACC)?

Accepted Answer

A)  7.9%% 
B)  8.3% 
C)  8.5% 
D)  9.3% 
E)  10.4% 
A)  7.9%% 
B)  8.3% 
C)  8.5% 
D)  9.3% 
E)  10.4%

Question 14

McDuffs' Moving and Storage has a capital structure which includes 1.5 million common shares selling at $15.00 per share with a dividend of $1.70 and a growth in dividends of 1.1% per year. Its newly issued 300,000 preferred shares have an issue and market price of $50, a term of 5 years and a fixed dividend of $4.50. McDuffs' nominal $40 million debt is perpetual with a interest rate of 7% and selling at $92 per $100 of nominal value. The company's tax rate is 28%. Using trial values of 6% and 12%, what is the company's weighted average cost of capital?

Accepted Answer

A)  7.8 
B)  8.3 
C)  8.4 
D)  9.0 
E)  9.3 
A)  7.8 
B)  8.3 
C)  8.4 
D)  9.0 
E)  9.3

Question 15

Which of the following is an internal source of long-term capital?

Accepted Answer

A)  Retained Earnings. 
B)  Common Shares 
C)  Preferred Shares 
D)  Bonds 
E)  Loans 
A)  Retained Earnings. 
B)  Common Shares 
C)  Preferred Shares 
D)  Bonds 
E)  Loans

Question 16

Which of the following is a quality that applies to preferred shares but not to bonds?

Accepted Answer

A)  Can be redeemable or irredeemable. 
B)  Have an agreed rate of return that is fixed over the life of the security. 
C)  Have a rate of return that cannot be written off against taxes. 
D)  Can be convertible or non-convertible. 
E)  Can be traded in the secondary securities markets. 
A)  Can be redeemable or irredeemable. 
B)  Have an agreed rate of return that is fixed over the life of the security. 
C)  Have a rate of return that cannot be written off against taxes. 
D)  Can be convertible or non-convertible. 
E)  Can be traded in the secondary securities markets.

Question 17

In the fifth year of operations both Sea Ltd. and Air Inc. had EBIT of $6 million. At the end of the year, the degree of financial leverage for Sea had decreased by 10% and for Air by 50%. What conclusion can be drawn from this?

Accepted Answer

A)  EBIT grew more quickly at Sea than at Air. 
B)  Air has relatively more capital payments than Sea. 
C)  EPS decreased more rapidly at Sea. 
D)  EBIT did not change by much at Air. 
E)  EPS remained at 90% of EBIt at Sea. 
A)  EBIT grew more quickly at Sea than at Air. 
B)  Air has relatively more capital payments than Sea. 
C)  EPS decreased more rapidly at Sea. 
D)  EBIT did not change by much at Air. 
E)  EPS remained at 90% of EBIt at Sea.

Question 18

Ignoring costs associated with new issues, what is the cost of retained earnings the same as?

Accepted Answer

A)  The cost of debt, as creditors have first call on retained earnings at the company's termination. 
B)  The weighted average cost of all the company's sources of capital as the company is indifferent as to the use of retained earnings or other sources. 
C)  The return on total assets as this ratio is equal to the sum of retained earnings plus dividends divided by total assets. 
D)  The cost of shares as retained earnings represent the undistributed profits belonging to the common shareholders. 
E)  The return on capital employed as retained earnings represents the opportunity cost of investment. 
A)  The cost of debt, as creditors have first call on retained earnings at the company's termination. 
B)  The weighted average cost of all the company's sources of capital as the company is indifferent as to the use of retained earnings or other sources. 
C)  The return on total assets as this ratio is equal to the sum of retained earnings plus dividends divided by total assets. 
D)  The cost of shares as retained earnings represent the undistributed profits belonging to the common shareholders. 
E)  The return on capital employed as retained earnings represents the opportunity cost of investment.

Question 19

Omaro Ltd. has $34 million worth of bonds outstanding with an interest rate of 8% and redemption in 4 years. The issue price of the bond is $90 per $100 of nominal value. The company's tax rate is 24%. Using trial values of 8% and 12%, what is the company's after tax cost of capital for the bonds?

Accepted Answer

A)  7.8% 
B)  8.6% 
C)  9.3% 
D)  11.3% 
E)  12.0% 
A)  7.8% 
B)  8.6% 
C)  9.3% 
D)  11.3% 
E)  12.0%

Question 20

An EBIT-EPS indifference chart for Rail Shipping Inc. indicates a breakeven point occurs at EBIT of $100 million. If the company issues shares to finance an expansion, EBIT will be $20 million below the indifference point. If bonds are issued, EBIt will be $30 million below the indifference point. What is the most appropriate conclusion to draw from this data?

Accepted Answer

A)  EBIT would have to increase 20% before issuing shares is a better alternative. 
B)  EBIT would have to increase 25% before issuing bonds is a better alternative. 
C)  EBIT would have to increase 30% before issuing shares is a better alternative. 
D)  EBIT would have to increase 43% before issuing bonds is a better alternative. 
E)  EBIT would have to increase 50% before issuing shares is a better alternative. 
A)  EBIT would have to increase 20% before issuing shares is a better alternative. 
B)  EBIT would have to increase 25% before issuing bonds is a better alternative. 
C)  EBIT would have to increase 30% before issuing shares is a better alternative. 
D)  EBIT would have to increase 43% before issuing bonds is a better alternative. 
E)  EBIT would have to increase 50% before issuing shares is a better alternative.

In the Traditional view, at what level of borrowing does the Optimal Capital Structure occur?

What is the cost of shares to the business is equivalent to?

Markle Ltd. has issued $7.5 million worth of bonds with an interest rate of 10%, payable annually, and redemption in 10 years. The issue price of the bond is $85 per $100 of nominal value. If Markle's tax rate is 35%, what is the cash flow each year that is associated with this debt?

Intelligent Corp. (IC) pays an annual dividend of $2.00 per share. IC announced it will start to grow the dividend by 15% per year from now on. If IC's shareholders require a 20% return on common shares, what should one share of IC stock sell for?

What is one strategy that a hedge fund uses to maximize shareholder wealth?

A company has 1.5 million 5% preferred shares with a nominal value of $50 and a market capitalization of $91.5 million. What is the cost of capital for the preferred shares?

How can dividends over the entire future life of a business be relevant to a short term investor?

If the risk co-efficient, beta, for McDonald's Corporation is .9, what can be said about the fluctuation of the company's returns?

Which of the following is an assumption of the Capital Asset Pricing Model?

Which of the following is an internal source of long-term capital?

Which of the following is a quality that applies to preferred shares but not to bonds?

In the fifth year of operations both Sea Ltd. and Air Inc. had EBIT of $6 million. At the end of the year, the degree of financial leverage for Sea had decreased by 10% and for Air by 50%. What conclusion can be drawn from this?

Ignoring costs associated with new issues, what is the cost of retained earnings the same as?

Omaro Ltd. has $34 million worth of bonds outstanding with an interest rate of 8% and redemption in 4 years. The issue price of the bond is $90 per $100 of nominal value. The company's tax rate is 24%. Using trial values of 8% and 12%, what is the company's after tax cost of capital for the bonds?

Introduction to Financial Management

Accounting - the Language of Business

Financial Planning and Pro Forma Financial Statements

Analyzing and Interpreting Financial Statements

The Time Value of Money

Making Capital Investment Decisions

Making Capital Investment Decisions: Further Issues

Financing a Business 1: Sources of Funds

Financing a Business 2: Raising Long-Term Funds

Developing a Dividend Policy

Managing Working Capital

Measuring and Managing for Shareholder Value

Mergers, Acquisitions, and the Valuation of Shares

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Exam 10: The Cost of Capital and the Capital Structure Decision

In the Traditional view, at what level of borrowing does the Optimal Capital Structure occur?

What is the cost of shares to the business is equivalent to?

Markle Ltd. has issued $7.5 million worth of bonds with an interest rate of 10%, payable annually, and redemption in 10 years. The issue price of the bond is $85 per $100 of nominal value. If Markle's tax rate is 35%, what is the cash flow each year that is associated with this debt?

Intelligent Corp. (IC) pays an annual dividend of $2.00 per share. IC announced it will start to grow the dividend by 15% per year from now on. If IC's shareholders require a 20% return on common shares, what should one share of IC stock sell for?

What is one strategy that a hedge fund uses to maximize shareholder wealth?

A company has 1.5 million 5% preferred shares with a nominal value of $50 and a market capitalization of $91.5 million. What is the cost of capital for the preferred shares?

How can dividends over the entire future life of a business be relevant to a short term investor?

If the risk co-efficient, beta, for McDonald's Corporation is .9, what can be said about the fluctuation of the company's returns?

Which of the following is an assumption of the Capital Asset Pricing Model?

Which of the following is an internal source of long-term capital?

Which of the following is a quality that applies to preferred shares but not to bonds?

In the fifth year of operations both Sea Ltd. and Air Inc. had EBIT of $6 million. At the end of the year, the degree of financial leverage for Sea had decreased by 10% and for Air by 50%. What conclusion can be drawn from this?

Ignoring costs associated with new issues, what is the cost of retained earnings the same as?

Omaro Ltd. has $34 million worth of bonds outstanding with an interest rate of 8% and redemption in 4 years. The issue price of the bond is $90 per $100 of nominal value. The company's tax rate is 24%. Using trial values of 8% and 12%, what is the company's after tax cost of capital for the bonds?

Introduction to Financial Management

Accounting - the Language of Business

Financial Planning and Pro Forma Financial Statements

Analyzing and Interpreting Financial Statements

The Time Value of Money

Making Capital Investment Decisions

Making Capital Investment Decisions: Further Issues

Financing a Business 1: Sources of Funds

Financing a Business 2: Raising Long-Term Funds

Developing a Dividend Policy

Managing Working Capital

Measuring and Managing for Shareholder Value

Mergers, Acquisitions, and the Valuation of Shares

Filters