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Section A: Answer Questions 1-20 on the Multiple Choice Answer Card. For
each question, select the one best answer.
1. Which of the following statements concerning capital budgeting is NOT true
A. It makes sense for smaller businesses to use payback period method as
it deals with time value of money well.
B. NPV and IRR can lead to the different conclusion in choosing between
mutually exclusive projects.
C. A project with zero NPV provides an average return that will just
compensate for the risk taken.
D. The reinvestment rate typically assumed in NPV calculation is the cost
of capital or the hurdle rate itself.
E. Among all capital budgeting tools, NPV is the most consistent with the
Value Based Management (VBM) principle.
2. Which of the following scenarios is appropriate to use WACC as the discount
rate in the NPV analysis
A. Bruno is considering an introduction of the new (but similar) products
of the company to the existing customers.
B. Ed is evaluating entering a new industry to diversify the company’s risk.
C. Sade is considering a speculative venture with a company’s Japanese
supplier.
D. Angela is looking into the project that will improve cost management
with known technology within the company.
E. Rebecca is evaluating whether buying a stock based on its current
price will add to her wealth.
3. The book value and market value of equity for XYZ Company is $200,000,000
and $300,000,000 respectively. The company has 1,000,000 shares
outstanding and the current share price is $300. The long-term debt of the
company is recorded as $600,000,000 (book value and market value equal).
The company’s net income is $20,000,000. What is the ROA of the company
A. 5 %
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B. 3.33%
C. 2.5%.
D. 1.5%
E. None of the above
= 20 mil/800 mil = 2.5%
4. What is the EAC of a project that has the present value of cost of $1 million
through its 10 year life time The discount rate involved is 7%.
A. $142,377.1
B. $153,769.3
C. $167,824.4
D. $175,093.5
E. None of the above
EAC = 1 mil/PVIFA(7%,10) = 1 mil/7.0236 = 142377.1
5. A project causes the company to increase the working capital balance to
$10,000 during the first year of its operation. The balance of working capital is
projected to decrease by 10% each year. The project will last for three years.
What will be the cash flows from ‘changes in working capital’ at the end of
year three
A. Cash outflow of $12,100
B. Cash inflow of $12,100
C. Cash outflow of $8,100
D. Cash inflow of $8,100
E. None of the above
= 10000(0.9^2) = 8,100 (cash inflow at the end of the project)
6. The cost of equity is 10% and the cost of debt 6%. Assuming that the target
debt / equity ratio is 3 (in market value term) and 2 (in book value term), and
the company tax rate is 30%, calculate the overall cost of capital for the
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company if interest expense CANNOT be used for corporate tax saving
purpose.
A. 5.65%
B. 6.00%
C. 6.80%
D. 7.55%
E. None of the above
= 3/4(6%)(1-0) + 1/4(10%) = 4.5% + 2.5% = 7%
7. Which of the following is associated with the lowest cost of capital for a firm
A. Internally generated funds (e.g. retained earnings)
B. Long-term bond
C. Preference shares
D. Ordinary shares
E. Call options
8. All else equal, an increase in operating leverage would:
A. increases the break-even point based on NPV and decreases the
accounting break-even point.
B. decreases the break-even point based on NPV and decreases the
accounting break-even point.
C. increases the accounting break-even point and decreases the break_x005f even point based on NPV.
D. increases the break-even point based on NPV and increases the
accounting break-even point.
E. None of the above.
9. You run a CAPM regression on a listed company and find the beta to be 1.5.
The entire long-term financing of this firm is 100 million dollars, of which 80
milllion dollars of this figure represents long-term debt. The rest is equity. What
is the beta which reflect the business risk of this company
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A. 0.3
B. 0.5
C. 0.7
D. 1.5
E. None of the above
βU = βL / (1 + D/E) = 1.5/ (1 + 80/20) = 1.5/5 = 0.3
10. Which of the following statements is not true
A. Assets with larger betas are more sensitive to idiosyncratic risk.
B. The market portfolio has a beta of one (Beta = 1).
C. The slope of the SML line is the market risk premium (Rm – Rf).
D. Beta of an asset can be negative.
E. In the context of SML, the expected return of a share with a beta of
0.96 will be lower than the expected return of the corresponding stock
market.
11. Which of the following is not true regarding financial ratio analysis
A. The quick ratio of a company will always be lower than its current ratio
as long as the company’s inventory balance is positive.
B. If the short-term assets of a firm are equal to its current liabilities, the net
working capital is negative and the current ratio is equal to zero.
C. Return on Assets (ROA) is not sensitive to the firm’s stock price.
D. Market-to-book (M/B) ratio compares the market price of the
company’s share to the company’s book value of equity per
share. The higher, the more expensive the company’s share is.
12. According to the pecking order of financing choices theory:
A. there is the optimal capital structure that a company targets for.
B. the extent of debt usage in a firm decreases with its profitability.
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C. the interest tax shield increase the firm value.
D. the bankruptcy costs decrease the firm value.
E. the existence of creditors reduce agency problems.
13. Which of the following financial ratios has no effect on the profitability of the
firm, according to the Modified Du Pont system
A. Total Assets Turnover
B. Profit Margin
C. Current ratio
D. Equity Multiplier
E. All of the above matter.
14. Daimaru Department Store Company is purely financed by Common stock that
is priced to offer an average return of 10% per year. Following the new CEO’s
direction that the company will become financially aggressive, the company
repurchases 80% of the stock and substitutes an equal value of debt yielding
7%. In the context of Modigliani and Miller, what will be the expected return on
the common stock of this company after refinancing, in the world without taxes
A. 32%
B. 28%
C. 22%
D. 20%
E. None of the above
Note: rE = rA + (D/E)(rA – rD)
RE = 0.10 + (0.8/0.2)[0.10 – 0.07] = 0.22 = 22% per year
15. A debt-free firm produces a constant (assumed to go on indefinitely) EBIT of
$100,000, each year with the cost of capital of 16%. The value of this firm is
_____________. If the firm decides to borrow one million dollar on a ten-year
loan from the bank at 8% interest rate, the value of the firm will become
_____________: Corporate tax rate is 20%.
A. $500,000 ; $123,547
B. $500,000 ; $607,362
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C. $625,000 ; $777,217
D. $625,000 ; $850,200
E. None of the above
= [100,000(1 – 0.2)/0.16] + 1mil(8%)(20%).PVIFA(8%,10)
= 500000 + (16000 x 6.7101)
= 500000 + 107,361.6
= 607,362 $
16. Which of the following is not true regarding levering and unlevering beta
A. βLevered ≥ βUnlevered
B. Beta from running a CAPM regression is unlevered beta.
C. βUnlevered represents business risk.
D. In deriving Levered Beta equation, Beta of debt is assumed as ‘0’.
E. In deriving Levered Beta equation, Beta of interest tax savings is
assumed as βUnlevered.
17. The following data on a merger is given:
