Corporate Finance

Which of the following represents a responsibility of a company's board of directors? A Implementation of strategy B Enterprise risk management C Considering the interests of shareholders only

B. The board typically ensures that the company has an appropriate enterprise risk management system in place.

An analyst gathered the following information about a private company and its publicly traded competitor: Comparable Companies Tax Rate (%) Debt/Equity Equity Beta Private company 30.0 1.00 NA. Public company 35.0 0.90 1.75 Using the pure-play method, the estimated equity beta for the private company is closest to: A 1.029. B 1.104. C 1.877

C.

The cost of which source of capital most likely requires adjustment for taxes in the calculation of a firm's weighted average cost of capital? A Common stock B Preferred stock C Bonds

C. Bonds are a form of debt that must be adjusted for taxes when calculating the weighted average cost of capital.

With regard to net present value (NPV) profiles, the point at which a profile crosses the horizontal axis is best described as: A the point at which two projects have the same NPV. B the sum of the undiscounted cash flows from a project C a project's internal rate of return when the project's NPV equal to zero.

Cis correct. The horizontal axis represents an NPV of zero. By definition, the project's IRR equals an NPV of zero.

Kim Corporation is considering an investment of 750 million won with expected after-tax cash inflows of 175 million won per year for seven years. The required rate of return is 10 percent. What is the project's: NPV? IRR? A 102 million won 14.0% B 157 million won 23.3% C 193 million won 10.0%

A

Shirley Shea has evaluated an investment proposal and found that its payback period is one year, it has a negative NPV and positive IRR. Is this combination of results possible ? A Yes. B No, because a project with a positive IRR has a positive NPV. C No, because a project with such a rapid payback period has a positive NPV.

A is correct. If the cumulative cash flow in one year equals to the outlay (so what we invest) and additional casflows are not very large this scenario is possible. For example, assume the outlay is 100, the cash flow in Year 1 is 100 and the casflow in Year 2 is 5. The required retum is 10 percent. This project would have a payback of 1.0 years, an NPV of -4.96, and an IRR of 4. 77%.

Q. A consultant sees the following information about a publicly listed company. - The company has a 12-person board of directors . - The board is chaired by the chief executive officer (CEO) of the company. - All members of the audit committee are outside directors with relevant financial and accounting experience. Which of the following changes would provide the greatest improvement in the corporate governance of this company? A The chairman of the board should be an independent director. B The company's Vice President of Finance should be a member of the audit committee. C The board of directors should have an odd number of directors to preclude tied votes.

A is correct. In good corporate governance practices the chair of the board and CEO roles are independent. If the chair of the board is a chief of the company, it may hamper efforts to undo the mistakes made by him or her as chief executive. There is a general trend in governence toward reduceded influence for executive directors, as exemplified by the decreasing incidence of CEO duality.

Which of the following features is most likely to be found in a well-structured executive compensation plan? A Links to factors that drive overall corporate performance B Reasonably consistent total compensation from year to year C Higher total remuneration relative to peer companies with comparable performance

A is correct. Plans that link compensation to the factors that drive overall corporate performance are well structured because they create alignment between shareholder and executive objectives.

Which of the following is not typically used to protect creditors' rights? A Proxy voting B Collateral to secure debt obligations C The imposition of a covenant to limit a company's debt level

A is correct. Proxy voting is a practice adopted by shareholders, not creditors. Both collateral and covenants are used by creditors to help mitigate the default risk of a company.

In an acquisition, the interests of minority shareholders are best protected through the use of A sell-out rights. B clawback provisions. C covenants within indentures.

A is correct. Sell-out rights protect minority shareholders in acquisition situations by forcing acquirers to buy out minority shareholders at a fair price, even if those shareholders initially voted against the acquirer's offer.

With regard to the net present value (NPV) profiles of two projects, the crossover rate is best described as the discount rate at which: A two projects have the same NPV B two projects have the same intermal rate of return C a project's NPV changes from positive to negative

A is correct. The crossover rate is the discount rate at which the NPV profiles for two projects cross, it is the only point where the NPV's of the projects are the same.

Q. When considering two mutually exclusive capital budgeting projects with conficting rankings-one has a higher positive net present value (NPV), the other has a higher internal rate of retum (IRR)-the most appropriate conclusion is to choose the project with the: A higher NPV B higher IRR C shorter payback

A is correct. The project with the higher NPV should be undertaken beceasue NPV measuers the increasein wealth as result of taking the project. For mutually exclusive projects, IRR may give incorrect decisions as a result of scale and/or cash fow timing effect.

A $2.2 million investment will result in the cash flows shown below: Year-End Cash Flow (millions) Year 1. $1.3 Year 2. $1.6 Year 3. $1.9 Year 4. $0.8 Using an 8% opportunity cost of capital, the project's net present value (NPV) is closest to: A $2.47 million. B $3.40 million. C $4.67 million.

A.

A company has a fixed $1,100 capital budget and has the opportunity to invest in the four independent projects listed in the table: Project Investment Outlay NPV 1. $600 $100 2. $500 $100 3. $300 $50 4. $200 $50 The combination of projects that provides the best choice is: A 2, 3, and 4. B 1,3, and 4 C 1 and 2

A.

When two mutually exclusive projects with conventional cash flows are being ranked the net present value (NPV) and internal rate of return (IRR) decision rules are most likely to conflict when the: A projects' investments are of different scale B projects have multiple IRRS C projects have similar timing of cash flows.

A. Conflict between the NPV and IRR decision rules can arise when evaluating mutually exclusive projects with conventional cash flows that 1) differ in scale and/or 2) the timing of the cash flows may differ. Multiple IRR will not occur in the projects with conventional cash flows.

Under the stakeholder theory, corporate governance is most consistent with a system of: A internal controls and procedures by which individual companies are managed. B defined roles for management and the majority shareowner(s). C checks and balances to minimize the conflicting interests among shareowners.

A. Corporate governance is the system of intemal controls and procedures by which individual companies are managed. Majority shareholder doesn't necessarily have a specific role that is defined through corporate governance. Corporate governance is primarily aimed at managing the conflicting interests between management and external shareholders, not amongst shareholders.

When computing the cash flows for a capital project, which of the following is least likely to be included? A Financing costs B Opportunity costs C Tax effects

A. Financing costs are not included in a cash flow calculation but are considered in the calculation of the of the discount rate.

Which of the following statements regarding ESG implementation methods is most accurate? A Negative screening is the most commonly applied method. B Thematic investing considers multiple factors. C Relative/best-in-class screening excludes industries with unfavorable ESG aspects.

A. Negative screening, which refers to the practice of excluding certain sectors, companies, or practices that violate accepted standards in such areas as human rights or environmental concerns, is the most common ESG investment style. Best in class screening doesn't exclude the companies with unfavourable ESG - it chooses the one that thane the best ESG comparing to peers.

Which of the following represents a principal-agent conflict between shareholders and management? A Risk tolerance B Multiple share classes C Accounting and reporting practices

A. Shareholder and manager interests can diverge with respect to risk tolerance. Shareholders can have a fairly high risk tolerance. Managers are typically more risk averse in their corporate decision making to better protect their employment status.

Q. Which of the following statements about non-market factors in corporate governance is most accurate? A Stakeholders can spread information quickly and shape public opinion. B A civil law system offers better protection of shareholder interests than does a common law system. C Vendors providing corporate governance services have limited influence on corporate governance practices.

A. Social media has become a powerful tool for stakeholders to instantly broadcast information with little cost or effort and to compete with company management in influencing public sentiment.

The primary motivation of activist shareholders is to promote: A improved shareholder value B environmentally sustainable business practices. C consideration of human rights in employee relations.

A. The primary motivation of activist shareholders is to increase shareholder value. If they feel management or the board has failed to act in the best interests of shareholders, they may attempt to force changes by gaining control of the board. ESG investors have to goal to invest in sustainble business practises and human rights.

Two years ago, a company issued $20 million in long-term bonds at par value with a coupon rate of 9 percent. The company has decided to issue an additional $20 million in bonds and expects the new issue to be priced at par value with a coupon rate of 7 percent. The company has no other debt outstanding and has a tax rate of 40 percent. To compute the company's weighted average cost of capital, the appropriate after-tax cost of debt is closest to: A. 4.2% B. 4.8% C. 5.4%

A. The relevant cost iş the marginal cost of debt. The before-tax marginal cost of debt can be estimated by the yield to maturity on a comparable outstanding After adjusting for tax, the after-tax cost is 7(1 -0.4) = 7(0.6) = 4 2%.

Q. An investment has an outlay of 100 and after-tax cash flows of 40 annually for four years. A project enhancement increases the outlay by 15 and the annual after-tax cash flows by 5. As a result, the vertical intercept of the NPV profile of the enhanced project shifts: A up and the horizontal intercept shifts left. B up and the horizontal intercept shifts right C down and the horizontal intercept shifts left.

A. The vertical intercept changes from 60 to 65 (NPV when cost of capital is 0%), and the horizontal intercept (IRR, when NPV equals zero) changes from 21.68 percent to 20.68 percent. I just computed boyh NPV and highier NPV will be highier on the vertical axis.

Which of the following scenarios can best be described as offering superior protection of shareholder interests? A When common law is practiced B When CEO duality is common C When stakeholder theory prevails

A. Unlike civil law systems, common law systems provide judges with the ability to create law by setting precedents that are followed in subsequent cases. Shareholders are viewed as better protected under common law because judges may rule against management actions situations that are not specifically addressed by statutes. Under CEO duality, the CEO also serves as chairperson of the board. All else equal, this decreases the protection of shareholder interests in favor of those of management. Stakeholder theory incorporates the interests of non-shareholders such as customers, suppliers, and employees. This inevitably dilutes the focus on shareholders.

A project has the following annual cash flows: Year 0 Year 1 Year 2 Year 3 Year 4 -$75,000 $21,600 $23,328 $37,791 $40,815 With a discount rate of 8%, the discounted payback period (in years) is closest to: A 3.0 B 3.2 C 2.8.

B

Kim Corporation is considering an investment of 750 million won with expected after-tax cash inflows of 175 million won per year for seven years. The required rate of return is 10 percent. Expressed in years, the project's payback period and discounted payback period, respectively, are closest to: A 4.3 years and 5.4 years. B 4.3 years and 5.9 years. C 4.8 years and 6.3 years.

B

Recent trends in corporate governance most likely include: A focusing on the corporate governance system's responsibility to maximize shareholder value. B expanding the scope to consider the interests of employees, customers, suppliers C increasing the diversity of corporate governance systems tailored to specific jurisdictions.

B

The component of stakeholder management in which a corporation has the most control is: A legal infrastructure. B contractual infrastructure. C governmental infrastructure.

B is correct. A corporation's contractual infrastructure refers to the contractual arrangements between the corporation and stakeholders. As such, the corporation has control over these arrangements. Legal infrastructure is established by law, which outside the corporation's own control. Similarly, Corporation's governmental structure is largely imposed by regulators.

A primary responsibility of a board's audit committee does not include the: A proper application of accounting policies. B adoption of proper corporate governance. C recommendation of remuneration for the external auditor(s)

B is correct. The adoption of proper corporate governance is the responsibility of a corporation's governance committee. Both proper application of accounting policies and the remuneration of external auditors fall under the domain of the audit committee.

Using the debt-rating approach to find the cost of debt is most appropriate when market prices for a company's debt are: A below par value B unreliable. C stable

B is correct. The debt-rating approach is used when the market prices for debt are unreliable or nonexistent A is incorrect because prices below par value is not an indicator of a price being unreliable C is incorrect because stable prices imply reliable prices.

Based on good corporate governance practices, independent board members most likely: A are pre-approved by management before being nominated. B have a "lead" director when the board chair is not independent. C hold large equity positions but have never worked at the company

B is correct. Under good corporate governance practices, independent board members should have a "lead" director when the board chair is not independent. A is incorrect because the Nomination Committee identifies qualified candidates for director positions, not management. C is incorrect because board members with a large stake in the company are not independent because they have a material ownership relationship with it.

A class of noncallable, nonconvertible preferred stock was issued at $45.00 per share with a dividend of $5.25. The preferred stock is now trading at $60.00 per share. Earnings of the company are growing at 3.00%. The cost of preferred stock is closest to: A. 11.7% B 8.8% C 5.8%

B.

A company issues new 20-year $1,000 bonds with a coupon rate of 6.2% payable semiannually at an issue price of $1,030.34. Assuming a tax rate of 28%, the firm's annual after-tax cost of debt (%) is closest to: A 5.94. B 4.28. C 4 46.

B.

A financial analyst at Buckco Ltd. wants to compute the company's weighted average cost of capital (WACC) using the dividend discount model. The analyst has gathered the following data: Before-tax cost of new debt 8 percent Tax rate 40 percent Target debt-to-equity ratio 0.8033 Stock price. $30 Next year's dividend $1.50 Estimated growth rate 7 percent Buckco's WACC is closest to: A 8 percent. B 9 percent. C 12 percent.

B.

A three-year investment requires an initial outlay of £1,000. It is expected to provide three year-end cash flows of £200 plus a net salvage value of £700 at the end of three years. What is the IRR closest to: A 10% B 11%. C 20%.

B.

An analyst gathered the following information about a company and the market: Current market price per share of common stock $28.00 Most recent dividend per share paid on common stock (D) $2.00 Expected dividend payout rate 40% Expected return on equity (ROE) 15% Beta for the common stock 1.3 Expected rate of return on the market portfolio 13% Risk-free rate of return 4% Using the Capital Asset Pricing Model (CAPM) approach, the cost of retained earmings for the company is desest to: A 13.6% B 15.7% C 16.1%

B.

Equity risk premium, Sweden 4.82 percent Risk-free rate of interest, Sweden 4.25 percent Industry debt-to-equity ratio 0,3 Market value of Kruspa's debt €900 million Market value of Kruspa's equity €2.4 billion Kruspa's equity beta 1.3 Kruspa's before-tax cost of debt 9.25 percent Trutan credit A2 country risk premium 1.88 percent Corporate tax rate 37.5 percent Interest payments each year Level In his estimation of the project's cost of capital Sandell would like to use the asset beta of Kruspa as a base in his calculations. The estimated asset beta of Kruspa prior to the Trutan project is closest to: A 1.053. B 1.110 C 1.327

B.

Equity risk premium, Sweden 4.82 percent Risk-free rate of interest, Sweden 4.25 percent Industry debt-to-equity ratio 0.3 Market value of Kruspa's debt €900 million Market value of Kruspa's equity €2.4 billion Kruspa's equity beta 1.3 Kruspa's before-tax cost of debt 9.25 percent Trutan credit A2 country risk premium 1.88 percent Corporate tax rate 37.5 percent Interest payments each year Level Using the capital asset pricing model, Kruspa's cost of equity capital for its typical project is closest to: A 7.62 percent. B 10.52 percent C 12.40 percent

B.

Q. An investment of $100 generates after-tax cash flows of $40 in Year 1, $80 in Year 2, and $120 in Year 3. The required rate of return is 20 percent. The net present value is closest to: A $42.22 B $58.33 C $68.52

B.

The following indormation is available for a company: Bonds are priced at par and have an annual coupon rate of 9.2%. Preferred stock is priced at $8 18 and pays an annual dividend of $1.35 Common equity has a beta of 1.3 The risk-free rate is 4% and the market premium is 11% Capital structure Debt = 30%, Preferred stock = 15% Common equity = 55% . The tax rate is 35% The weighted average cost of capital (WACC) for the company is closest to A 11.5% B 143%. C 13 4%

B.

The following table shows the incremental after-tax cash flows (in S millions) for three independent investments: Year 1. 2. 3. 4. 5. Investment 1 -80 0 0 60 60 Investment 2 -125 35 60 80 -20 Investment 3 -100 11 11 11 11 11 into perpetuity The opportunity cost of capital (r) is 12%. A company is most likely to undertake which investment(s)? A Investments 1 and 2 B Investment 1 only C Investments 2 and 3

B. 1. NPV = 0.84 2. NPV= -1.69 3. NPV = -100 + 11/0.12= -8.33

The component of stakeholder management in which a corporation has the most control is: A legal infrastructure. B contractual infrastructure. C governmental infrastructure.

B. A corporation's contractual infrastructure refers to the contractual arrengments between the corporation and stakeholders. As such corporation has control on them. A is incorrect because the legal infrastructure is established by law, which is outside of the corporation's own control. Similarly, C is incorrect because a corporation's governmental structure is largely imposed by regulators.

Equity risk premium, Sweden 4. 82 percent Risk-free rate of interest, Sweden 4.25 percent Industry debt-to-equity ratio 0.3 Market value of Kruspa's debt €900 million Market value of Kruspa's equity €2.4 billion Kruspa's equity beta 1.3 Kruspa's before-tax cost of debt 9 25 percent Trutan credit A2 country risk premium 1.88 percent Corporate tax rate 37.5 percent Interest payments each year Level Sandell is interested in the weighted average cost of capital of Kruspa AB prior to its investing in the Trutan project This weighted average cost of capital (WACC) is closest to: A 7.65 percent B 9 23 percent. C 10.17 percent

B. Always remember use market value for targeted weight of debt and equity!

With regard to capital budgeting, an appropriate estimate of the incremental cash flows from a project is least likely to include: A externalities. B interest costs. C opportunity costs.

B. Costs to finance the project are taken into account when the cash flows are discounted at the appropriate cost of capital. Inluding interest cost in the cash flows would result in double-counting the cost of debt.

Which of the following conditions is most likely to facilitate shareholder activism? A Cross-shareholdings B Cumulative voting C Staggered boards

B. Cumulative voting facilitates shareholder activism by allowing shareholders to accumulate and vote all their shares for a single candidate in an election involving more than one candidate. Minority shareholders, who maybe activist are more likely to successfully elect a board member in this way. Cross-shareholdings inhibit shareholder activism because the management teams of the cross-held companies implicitly agree to use their votes to support each other's interests. Staggered boards inhibit shareholder activism by limiting the number of board members elected in a given year. This makes it difficult to implement immediate change.

Which of the following statements is correct? A The appropriate tax rate to use in the adjustment of the before-tax cost of debt to determine the after-tax cost of debt is the average tax rate because interest is deductible against the company's entire taxable income. B For a given company, the after-tax cost debt is generally less than both the cost of preferred equity and the cost of common equity C For a given company, the investment opportunity schedule is upward sloping because as a company invests more in capital projects the returns from investing increase

B. Debt is generally less costly than preferred or common stock. The cost of debt is further reduced if interest expense is tax deductible.

Consider the two projects below. The cash flows as well as the NPV and IRR for the two projects are given. For both projects, the required rate of return is 10 percent Cash Flows Year 0. 1. 2. 3 4. NPV IRR (%) Project 1 -100 36 36 36 36 14.12 16.37 Project 2 -100 0. 0. 0. 175 19.53 15.02 What discount rate would result in the same NPV for both projects? A A rate betwveen 0.00 percent and 10.00 percent. B A rate between 10.00 percent and 15.02 percent. C A rate between 15.02 percent and 16.37 percent

B. For these projects, discount rate of 13.16 percent would yield the same NPV for both (an NPV of 6.73).

The incremental after-tax cash flows (in € thousands) and information on two mutually exclusive projects are as follows: Year Project X -15,000 2,000 5,000 8,000 8,000 354.0 16.0 Project Y -13,250. 200. 500 7,000 15,000 ? ? The appropriate hurdle rate to use in evaluating the projects is 15.0%. Which of the following statements is mdst accurate? The company should accept A Both projects B Project Y only C Project X only

B. NPV project Y=480. The projects are mutually exclusive therefore we onl6 take into account NPV.

Which of the following statements regarding stakeholder management is most accurate? A Company management ensures compliance with all applicable laws and regulations. B Directors are excluded from voting on transactions in which C The use of vanable incentive plans in executive remuneration is decreasing. they hold material interest.

B. Often, policies on related-party transactions require that such transactions or matters be voted on by the board (shareholders) exluding holding the interest. Board supervises audit control risk management and proper governance systems and compliance with laws and regulations.

Erin Chou is reviewing a profitable investment project that has a conventional cash flow pattern. If the cash flows for the project, initial outlay, and future after-tax cash flows all double, Chou would predict that the IRR would: A increase and the NPV would increase. B stay the same and the NPV would increase. C stay the same and the NPV would stay the same

B. The IRR would stay the same because both the initial outlay and the after-tax cash flows double, so that the return on each dollar invested remains the same. All of the cash flows between and their present values double. The difference between total present value of the future cash flows and the initial outlay (the NPV) also doubles.

The cost of equity is equal to the: A expected market return B rate of return required by stockholders C cost of retained earnings plus dividends

B. The cost of equuity is defined as the rate of return required by stockholders. When investors (either lenders/bondholders or shareholders) invest in our company they require return for the fact they cannot use this money. This return from our perspective is cost of capital.

Which of the following issues discussed ata shareholders' general meeting would most likely require only a simple majority vote for approval? A Voting on a merger B Election of directors C Amendments to bylaws

B. The election of directors is considered an ordinary resolution and, therefore, requires only a simple majority of votes to be passed.

Which of the following statements is the most accurate description concerning the internal rate of return (IRR) method? IRR: A is the preferred method for evaluating mutually exclusive projects. B assumes that all cash flows from a project will be reinvested at the computed IRR. C is sensitive to changes in the firm's weighted average cost of capital.

B. The internal rate of return method assumes that the cash flows from a project are reinvested at the project's IRR; the net present value (NPV) method assumes that cash flows are reinvested at the cost of capital. IRR method is not sensitive to WACC but sensitive to the timing and pattern of the cashflows. In particular, when a project has a nonconventional cash flow pattern, there may be multiple IRRS or no IRR.

Q. A company's optimal capital budget most likely occurs at the intersection of the: A net present value and internal rate of return profiles B margnal cost of capital and investment opportunity schedule C marginal cost of capital and net present value profiles

B. The point at which the marginal cost of capital intersects the investment opportunity schedule is the optimal capital budget.

Q. A company has 100 million shares outstanding. The share price of a company's stock is £15 just prior to announcing a E100 million expansionary investment in a new plant, and the company estimates that the present value of future after-tax cash flows will be £150 million. Analysts, however, estimate that the new plant's profitability will be lower than the company's expectations The company's stock price will most likely: A drop below £15 per share due to the cannibalization of revenue from the new plant. B increase by less than £0.50 per share. C increase by the new plant's net present value per share

B. The value of a company is the value of its existing investments plus the net present values of all of its future investments. The NPV of this new plant is £150 million - £100 million = £50 million. The price per share should increase by NPV per share £50milion/100 million shares = £0.50 per share. As the new plant's profitability is less than expectations yhe NPV per share (and hence the increase in stock price) should be slightly below £0.50 per share.

The Gearing Company has an after-tax cost of debt capital of 4 percent, a cost of preferred stock of 8 percent, a cost of equity capital of 10 percent, and a weighted average cost of capital of 7 percent. Gearing intends to maintain its current capital structure as it raises additional capital. In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is: A 4 percent B 7 percent C 8 percent.

B. The weighted average cost of capital, using weights derived from the current capital structure, is the best estimate of the cost for average-risk project of a company.

When computing the weighted average cost of capital (WACC) and assuming a fixed-rate non-callable bond is currently selling above par value, the before-tax cost of debt is closest to the: A coupon rate. B yield to maturity C current yield

B. With a fixed-rate non-callable bond, the before-tax cost of debt is the bond's yield to maturity.

Which group of company stakeholders would be least affected if the firm's financial position weakens? A Suppliers B Customers C Managers and employees

Bis correct.

Wang Securities had a long-term stable debt-to-equity ratio of 0.65. Recent bank borrowing for expansion into South America raised the ratio to 0.75, The increased leverage has what effect on the asset beta and equity beta of the company? A The asset beta and the equity beta will both rise. B The asset beta will remain the same and the equity beta will rise C The asset beta will remain the same and the equity beta will decline.

Bis correct. Asset risk does not change with a higher debt-to-equity ratio. Equity risk rises with higher debt.

A mining company has received government approval for the development of a mining property and has also consulted with members of the local community near the development site throughout the project assessment process. The latter action is best described as an example of: A principal-agent conflict mitigation. B stakeholder management. C regulatory compliance

Bis correct. Stakeholder theory broadens a company's focus beyond the interests of only its shareholders to those of its customers, suppliers, employees, and others who have an interest in the company. The local community is likely a stakeholder in the company's development plans.

Morgan Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors. The stock was issued at $25 per share with a $1.75 dividend, If the company were to issue preferred stock today, the yield would be 6.5 percent. The stock's current value is: A $25.00. B $26.92 C $37.31.

Bis correct. The company can issue preferred stock at 6.5% P= $1.75/0.065 = $26.92

Brandon Wiene is a financial analyst covering the beverage industry. He is evaluating the impact of DEF Beverage's new product line of flavored waters. DEF currently has a debt-to-equity ratio of 0.6. The new product line would be financed with $50 million of debt and $100 million of equity. In estimating the valuation impact of this new product line on DEF's value, Wiene has estimated the equity beta and asset beta of comparable companies. In calculating the equity beta for the product line, Wiene is intending to use DEF's existing capital structure when converting the asset beta into a project beta. Which of the following statements is correct? A Using DEF's debt-to-equity ratio of 0.6 is appropriate in calculating the new product line's equity beta B Using DEF's debt-to-equity ratio of 0.6 is not appropriate, but rather the debt-to-equity ratio of the new product 0.5 is appropriate to use in calculating the new product line's equity bęta, C Wiene should use the new debt-to-equity ratio of DEF that would result from the additional $50 milion debt and $100 million equity in calculating the new product line's equity beta.

Bis correct. The debt-to-equity ratio of the new product should be used when making the adjustment from the asset beta derived from the comparables, to the equity beta of the new product.

With regard to net present value (NPV) profiles, the point at which a profile crosses the vertical axis is best described as: A the point at which two projects have the same NPV. B the sum of the undiscounted cash flows from a project. C a project's internal rate of return when the project's NPV is equal to zero.

Bis correct. The vertical axis represents a discount rate of zero. The point where the profile crosses the vertical axis is simply the sum of the cash flows.

Which of the statements about extraordinary general meetings (EGMS) of shareholders is true? A The appointment of external auditors occurs during the EGM. B A corporation provides an overview of corporate performance at the EGM. C An amendment to a corporation's bylaws typically occurs during the EGM.

C is correct. An amendment to corporate bylaws would normally take place during an EGM, which covers significant changes to a company, such as bylaw amendments. The appointment of external auditors and a corporate performance overview would typically take place during the AGM.

Which statement regarding corporate governance is most accurate? A Most countries have similar corporate governance regulations. B A single definition of corporate govemance is widely accepted in practice. C Both shareholder theory and stakeholder theory consider the needs of a company's shareholders.

C is correct. Both shareholder and stakeholder theories consider the needs of shareholders, with the latter extending to a broader group of stakeholders. Corporate governance regulations differ across countries, although there is a trend toward convergence. Universally accepted definition of corporate governance remains elusive.

A company's management team is proposing to sell a major division industry because of low future growth prospects . To which committee of the board is the proposal most likely to be presented? A Risk B Audit C Investment

C is correct. Management is most likely review the viability of material investment opportunities present the proposed sale to the investment committee, whose main role is to proposed by management. of the company The risk committee assists the board in determining the risk policy, profile, and appetite.

Which stakeholders would most likely realize the greatest benefit from a significant increase in the market value of the company? A Creditors B Customers C Shareholders

C is correct. Shareholders own shares of stock in the company, and their wealth is directly related to the market value of the company.

Which of the following is most likely associated with a strong corporate code of ethics? The code of ethics is: A updated at least every 10 years B signed by employees on a voluntary basis C developed and its implementation overseen by the governance committee

C is correct. The governance committee typically develops and oversees implementation of the company's code of ethics. Ais incorrect because the code of ethics should be reviewed on a regular basis to incorporate relevant developments and new regulatory requirements. A review period of 10 years is too long B incorrect because codes of ethics establish the company's values and standards of ethical behavior and must be followed.

Q. Which of the following statements about environmental, social, and governance (ESG) in investment analysis is correct? A ESG factors are strictly intangible in nature. B ESG terminology is easily distinguishable among investors. C Environmental and social factors have been adopted in investment analysis more slowly than governance factors.

C is correct. The risks of poor corporate governance have long been understood by analysts and shareholders. In contrast, the practice of considering environmental and social factors has been slower to take hold.

An analyst gathered the following information about a company and the market: Current market price per share of common stock $28.00 Most recent dividend per share paid on common stock (Do) $2.00 Expected dividend payout rate 40% Expected returm on equity (ROE) 15% Beta for the common stock 1.3 Expected rate of return on the market portfolio 13% Risk-free rate of return 4% Using the discounted cash flow (DCF) approach, the cost of retained earnings for the company is closest to: A 15.7% B 16.1% C 16.8%

C.

An investment of $150,000 is expected to generate an after-tax cash flow of $100,000 in one year and another $120,000 in two years. The cost of capital is 10 percent. What is the internal rate of return? A 28.39 percent. B 28.59 percent C 28.79 percent.

C.

Dot Com has determined that it could issue $1,000 face value bonds with an 8 percent coupon paid semi-annually and a five-year maturity at $900 per bond. If Dot Com's marginal tax rate is 38 percent, its after-tax cost of debt is closest to: A 62 percent B 64 percent C 66 percent

C.

Equity risk premium, Sweden 4.82 percent Risk-free rate of interest, Sweden 4.25 percent Industry debt-to-equity ratio 0.3 Market value of Kruspa's debt €900 million Market value of Kruspa's equity €24 billion Kruspa's equity beta 1.3 Trutan credit A2 Kruspa's before-tax cost of debt 9.25 percent country risk premium 1.88 percent Corporate tax rate 37.5 percent Interest payments each year Level Sandel is performing a sensitivity analysis of the effects of the new project on the company's cost of capital. If Trutan project has the same asset risk as Kruspa, the estimated project beta for the Trutan project, if it is financed 80 % with debt is closest: A. 1.3 B. 2.635 C. 3.686

C.

Fran McClure of Alba Advisers is estimating the cost of capital of Frontier Corporation as part of her valuation analysis of Frontier. McClure will be using this estimate, along with projected cash flows from Frontier's new projects, to estimate the effect of these new projects on the value of Frontier. McClure has gathered the following information on Frontier Corporation: Current Year ($) Forecasted for Next Year ($) Book value of debt. 50 50 Market value of debt. 62 63 Book value of shareholders' equity 55 58 Market value of shareholders' equity 210 220 The weights that McClure should apply in estimating Frontier's cost of capital for debt and equity are, respectively: A w(d)= 0.200; w(e)= 0.800. B W(d)=0.185; w(e)= 0.815 C C w(d)=0.223, w(e) = 0.777.

C.

Given a discount rate of 10%, the net present value (NPV) of the following investment is closest to. Time 0. 1. 2. 3. 4. 5. 6. Cash flow -1,500 300 600 1,000 200 500 300 A 605. B 578. C 636

C.

Given the following cash flows for a capital project, calculate its payback period and discounted payback period. The required rate of return is 8 percent. Year 0. 1. 2. 3. 4. 5. Cash flow -50,000 15,000 15,000 20,000 10,000 5,000 The discounted payback period is: A 0.16 years longer than the payback period. B 0.51 years longer than the payback period. C 1.01 years longer than the payback period.

C.

Given the following information about a firm: • debt-to-equity ratio (D/E) of 50% * tax rate of 40% - cost of debt of 8% * cost of equity of 13% the firm's weighted average cost of capital (WACCC) is closest to: A 8.9%. B 7.5%. C 10.3%.

C.

Q. An investment of $20,000 will create a perpetual after-tax cash flow of $2,000. The required rate of return is 8 percent. What is the investment's profitability index? A 1.08. B 1.16. C 1.25.

C.

The net present value (NPV) of an investment is equal to the sum of the expected cash flows discounted at the: A internal rate of return. B risk-free rate. C opportunity cost of capital.

C.

Using the dividend discount model, what is the cost of eguity capital for Zeller Mining if the company will pay a dividend of C$2.30 next year, has a payout ratio of 30 percent, a return on equity (ROE) of 15 percent, and a stock price of C$45? A 9.61 percent. B 10.50 percent. C 15.61 percent.

C.

Which of the following is true of shareholder activism? A Shareholder activists rarely include hedge funds. B Regulators play a prominent role in shareholder activism. C A primary goal of shareholder activism is to increase shareholder value.

C. Although the subject of shareholder activism may involve social and political issues, activist shareholders' primary motivation is to increase shareholder value. A is incorrect because hedge funds commonly serve as shareholder activists. B is incorrect because regulators play a prominent role in standard setting, not shareholder activism.

Corporate govermance: A complies with a set of global standards. B is independent of both shareholder theory and stakeholder theory C seeks to minimize and manage conflicting interests between insiders and extermal shareholders.

C. Corporate governance is the arrangement of checks, balances, and incentives a company needs to minimize and manage the conflicting interests between insiders and external shareholders.

Wilson Flannery is concerned that this project has multiple IRRS. Year 0. 1. 2. 3 Cash flows -50 100 0 -50 How many discount rates produce a zero NPV for this project? A One, a discount rate of 0 percent. B Two, discount rates of 0 percent and 32 percent. C Two, discount rates of 0 percent and 62 percent

C. Discount rates of 0 percent and approximately 61.8 percent bothgive a zero NPV

Which of the following is most consistent with good corporate governance practices? A All stakeholders should have the right to participate in the governance of the firm. B An audit committee that benefits from the direct guidance of management. C Appropriate controls and procedures to effectively manage the firm should be in place.

C. Effective corporate governance requires a system of appropriate controls and procedures to protect financial markets and investors. A is incorrect because only shareholders have the right (not all stakeholders) to participate in the governance of the firm. B is incorrect because the audit and compensation committees are best structured with exclusively independent directors, and no management involvement.

When estimating the NPV for a project with a risk level higher than the company's average risk level, an analyst will most likely discount the project's cash flows by a rate that is: A determined by the firm's target capital structure B below the WACC C above the WAC

C. If the systematic risk of the project is above average relative to the company's current portfolio of projects, an upward adjustment is made to the company's MCC or WACC.

A controlling shareholder of XYZ Company owns 55% of XYZ's shares, and the remaining shares are spread among a large group of shareholders. In this situation, conflicts of interest are most likely to arise between: A shareholders and regulators. B the controlling shareholder and managers. C the controlling shareholder and minority shareholders.

C. In this ownership structure, the controlling shareholder's power is likely more influential than that of minority shareholders. Thus, the controlling shareholder may be able to exploit its position to the detriment of the interests of the remaining shareholders. Ownership structure in and of itself is unlikely to create material conflicts between shareholders and regulators or shareholders and managers.

Hermann Corporation is considering an investment of €375 million with expected after-tax cash inflows of €115 million per year for seven years and an additional after-tax salvage value of €50 million in Year 7. The required rate of return is 10 percent. What is the investment's PI? A 1.19 B 1.33. C 1.56.

C. PI= NPV/Initial investment + 1 !!!!

When dealing with mutually exclusive projects, the most reliable decision rule is: A time-weighted rate of return. B IRR C NPV.

C. The NPV rule's assumption about reinvestment rates is more realistic and more economically relevant as the IRR rule because it incorporates the market-determined opportunity cost of capital as a discount rate. In contrast, the IRR calculation assumes reinvestment at the IRR, which sometimes cannot be achieved because it is too high. Time-weighted rate of return suffers similar shortcomings as IRR.

The cost of debt can be determined using the yield-to-maturity and the bond rating approaches. If the bond rating approach is used, the: A coupon is the yield. B yield is based on the interest coverage ratio. C company is rated and the rating can be used to assess the credit default spread of the company's debt

C. The bond rating approach depends on knowledge of the company's rating and can be compared with yields on bonds in the public market.

The internal rate of returm (IRR) is best described as the: A opportunity cost of capital. B time-weighted rate of return. c discount rate that makes the net present value equal to zero.

C. The internal rate of return is computed by identifying all cash flows and solving for the rate that makes the net present value of those cash flows equal to zero.

Which of the following statements regarding corporate shareholders is most accurate? A Cross-shareholdings help promote corporate mergers. B Dual-class structures are used to align economic ownership with control. C Affliated shareholders can protect a company against hostile takeover bids

C. The presence of a sizable affiliated stockholder (such as an individual, family trust, endowment, or private equity fund) can shield a company from the effects of voting by outside shareholders.

When considering two mutually exclusive capital budgeting projects with conflicting rankings, the most appropriate conclusion is to choose the project with the: A shorter payback B higher internal rate of returm (IRR) C higher net present value (NPV)

C. The project with the higher NPV should be undertaken because it measures the increase in wealth as a result of taking the project. For mutually exclusive projects, IRR may give incorrect decisions as a result of scale and/or cash flow timing effects.

Q. A company that wants to determine its cost of equity gathers the following information: Rate of return on 3-month Treasury bills 3.0% Rate of return on 10-year Treasury bonds 3.5% Market risk premium 6.0% The company's equity beta 1.6 Dividend growth rate 8.0% Corporate tax rate 35% Using the capital asset pricing model (CAPM) approach, the cost of equity (%) for the company is closest to: A 12.6%. B 7.5% C 13.1%

Cis correct. CAPM: Cost of equity = Risk-free rate + Beta x Market risk premium = 3.5% + 1.6 x (6.0%) = 13.1%

Q. The least likely reason investors incorporate environmental and societal factors into their investment analysis is to: A improve investment performance B have a more comprehensive understanding of a company's risks. C limit investments to those equities that are consistent with their moral or ethical values.

Cis correct. Environmental, social, and governance investment analysis can be implemented across all assets classes and is not limited to equity investments. It is done to provide a more comprehensive understanding of a company's risks and improve investment performance.

Projects 1 and 2 have similar outlays, although the patterns of future cash flows are different. The cash flows as well as below. For both projects, the required rate of return is 10 percent. Cash Flows Year 0 1. 2. 3. 4. NPV IRR (%) Project 1 -50 20 20 20 20 13.40 21.86 Project 2 -50 0. 0. 0. 0 100 18.30 18.92 The two projects are mutually exclusive. What is the appropriate investment decision? A Invest in both projects B Invest in Project 1 because it has the higher IRR C Inwest in Project 2 because it has the higher NPV

Cis correct. For mutually exclusive projects always choose by NPV!

According to good corporate governance practices, which of the folowing committees is most likely to have members from executive management? A Remuneration B Audit C Environmental health and safety

Cis correct. In good corporate governance practices the audit and remuneration/compensation committees should be composed entirely of independent board members. Other committees such as environmental health and safety may have members from executive management. A is incorrect because the remuneration/compensation committee should be composed entirely of independent board members B is incorrect because the audit committee should be composed entirely of independent board members.

Which of the following is the best example of a good corporate governance practice? A Independent board members are prior, but not current employees of the firm B Supervisory and management boards have overlapping membership. C The chief executive position is separate from the chair position on the company's board.

Cis correct. The CEO and board chair roles should be separated to prevent too much executive power, A is incorrect because former employees are not independent board members. B is incorrect because supervisory and management boards should be independent of each other.

B. The company's weighted average cost of capital (WACC) is calculated as WACC = 0.5(6%) + 0.1(10%) + 0.4(15%) = 10%. In this scenario, the company should accept projects that have an internal rate of return greater than the cost of capital. The equipment project's IRR exceeds the WACC. The warehouse project does not.

Question

Freitag Corporation is investing €600 million in distribution facilities. The present value of the future after-tax cash flows is estimated to be €850 million. Freitag has 200 milion outstanding shares with current market price of €32.00 per share. This investment is new information, and is independent of other expectations about the company. What should be the effect of the project on the value of the company and the stock price?

The NPV of the project is €850 million - €600 million = €250 million. The total market value of the company prior to the investment is €32.00 x 200 million shares = €6,400 million. The value of the company should increase by €250million to €6,650 million. The price per share should increase by the NPV per share, or €250 million/200 million shares = €1.25 per share(from €32.00 to €33 25)