Financial Instruments Cost of Capital Qs PDF

Part 2 : Financial Instruments
Question 1 - HOCK RRI 9 - Risk and Return
An efficient portfolio is a portfolio that is in the feasible set of portfolios and
A. offers the highest possible expected return for a given level of risk or offers the lowest possible risk for a given level
of expected return.
B. offers the highest possible expected return for the lowest possible level of risk.
C. its historical returns have been above those of its benchmark for 8 of the last 10 years.
D. offers the lowest possible risk for the highest possible expected return.
All of the following are true about the beta coefficient except
A. The beta coefficient measures non-market risk.

B. The beta coefficient is used to measure a stock's market risk.
C. The beta coefficient of an investment measures how sensitive the stock's return is to changes in the market's return.
D. The beta coefficient is the slope of the regression line that relates the return of an individual security to the return of
its benchmark index.
Question 3 - ICMA 1603.P2.073 - Risk and Return
Using the capital asset pricing model, an analyst has calculated an expected risk-adjusted return of 17% for the
common stock of a company. The company’s stock has a beta of 2, and the overall expected market return for
equities is 10%. The risk-free return is 3%. All else being equal, the expected risk-adjusted return for the company’s
stock would increase if the
A. beta of the company's stock decreases.

B. overall expected market return for equities decreases.
C. volatility of the company's stock decreases.
D. risk-free return decreases.
Question 4 - HOCK CMA P2 SDV3 - Risk and Return
New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate
of 25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to
slow down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is
expected to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.
What is the risk premium that investors require to invest in New Company's stock?
A. 16%
B. 4%
C. 12%
D. 10%

If the risk-free rate is 4% and the expected return on the market is 9%, the risk premium for a security with a beta of
0.5 is
A. 2.5%
B. 6.5%
C. 50%
D. 5%
Which one of the following would have the least impact on a firm's beta value?
A. Operating leverage.
B. Industry characteristics.
C. Debt-to-equity ratio.
D. Payout ratio.
Question 7 - HOCK CMA P2 SDV1 - Risk and Return
New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate
of 25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to
slow down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is
expected to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.
What is the expected market rate of return?
A. 16.0%
B. 10.67%
C. 12.0%
D. 14.67%
Question 8 - CIA 1191 IV.60 - Risk and Return
The risk of loss because of fluctuations in the relative value of foreign currencies is called
A. Expropriation risk.
B. Multinational beta.
C. Undiversifiable risk.
D. Exchange rate risk.
What kind of risk can be eliminated by diversification in a portfolio?
A. Market risk
B. Systematic risk
C. Unsystematic risk
D. Portfolio risk
The beta coefficient for the market as a whole
A. is −1.
B. is zero.
C. cannot be determined.
D. is 1.
Question 11 - CMA 697 1.11 - Risk and Return
When purchasing temporary investments, which one of the following best describes the risk associated with the ability
to sell the investment in a short period of time without significant price concessions?
A. Financial risk.
B. Liquidity risk.
C. Interest-rate risk.
D. Purchasing-power risk.
Based on the assumptions of the Capital Asset Pricing Model, the risk premium on an investment with a beta of 0.5 is
equal to
A. half the risk premium on the market.

B. the risk-free rate.
C. the risk premium on the market.
D. twice the risk premium on the market.
Question 13 - CIA 589 IV.49 - Risk and Return
Which of the following classes of securities are listed in order from lowest risk/opportunity for return to highest
risk/opportunity for return?
A. Corporate income bonds; corporate mortgage bonds; convertible preferred stock; subordinated debentures.
B. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.
C. Common stock; corporate first mortgage bonds; corporate second mortgage bonds; corporate income bonds.
D. Preferred stock; common stock; corporate mortgage bonds; corporate debentures.
The systematic risk of an individual security is measured by the
A. standard deviation of the security's returns and other similar securities.

B. covariance between the security's returns and the general market.
C. security's contribution to the portfolio risk.
D. standard deviation of the security's rate of return.
Question 15 - ICMA 01.P2.127 - L-T Financial Management-Financial Instruments
Which one of the following describes a disadvantage to a firm that issues preferred stock?
A. Preferred stock typically has no maturity date.

B. Preferred stock is usually sold on a higher yield basis than bonds.
C. Preferred stock dividends are legal obligations of the corporation.
D. Most preferred stock is owned by corporate investors.
All of the following are characteristics of preferred stock except that
A. it may be callable at the option of the corporation.

B. its dividends are tax deductible to the issuer.
C. it may be converted into common stock.
D. it usually has no voting rights.
Question 17 - CFM Sample Q. 10 - L-T Financial Management-Financial Instruments
Rogers Inc. operates a chain of restaurants located in the Southeast. The company has steadily grown to its present
size of 48 restaurants. The board of directors recently approved a large-scale remodeling of the restaurant, and the
company is now considering two financing alternatives.
The first alternative would consist of

Bonds that would have a 9% effective annual rate and would net $19.2 million after flotation costs
Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
Common stock that would yield $24 million after a 5% flotation cost
The second alternative would consist of a public offering of bonds that would have an 11% effective annual rate and
would net $48 million after flotation costs.
Rogers' current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred stock,
and 50% common stock. The current market value of the common stock is $30 per share, and the common stock
dividend during the past 12 months was $3 per share. Investors are expecting the growth rate of dividends to equal
the historical rate of 6%. Rogers is subject to an effective income tax rate of 40%.
The interest rate on the bonds is greater for the second alternative consisting of pure debt than it is for the first
alternative consisting of both debt and equity because
A. The combination alternative carries the risk of increasing dividend payments.

B. The pure debt alternative carries the risk of increasing the probability of default.
C. The pure debt alternative would flood the market and be more difficult to sell.
D. The diversity of the combination alternative creates greater risk for the investor.
Question 18 - CMA 695 1.2 - L-T Financial Management-Financial Instruments
Which one of the following statements is correct when comparing bond financing alternatives?
A. A call provision is generally considered detrimental to the investor.

B. A bond with a call provision typically has a lower yield to maturity than a similar bond without a call provision.
C. A convertible bond must be converted to common stock prior to its maturity.
D. A call premium requires the investor to pay an amount greater than par at the time of purchase.
The best reason corporations issue Eurobonds rather than domestic bonds is that:
A. These bonds are denominated in the currency of the country in which they are issued.
B. Foreign buyers more readily accept the issues of both large and small U.S. corporations than do domestic investors.
C. These bonds are normally a less expensive form of financing because of the absence of government regulation.
D. Eurobonds carry no foreign exchange risk.
Wilton Corporation has 5,000 shares of 6% cumulative, $100 par value, preferred stock outstanding and 175,000
shares of common stock outstanding. No dividends have been paid by the company since May 31, year 2. For the
year ended May 31, year 4, Wilton had net income of $1,450,000 and wishes to pay common shareholders a dividend
equivalent to 25% of net income. The total amount of dividends to be paid by Wilton Corporation at May 31, year 4 is:
A. $362,500.
B. $407,500.
C. $422,500.
D. $392,500.
Question 21 - CIA 592 IV.48 - L-T Financial Management-Financial Instruments
The maximum acquisition value of an inefficiently run corporation is the discounted net present value of the
A. Current market value of the firm.

B. Current earnings before interest and taxes (EBIT).
C. Expected future cash flow.
D. Current net profits.
Gleason Industries is about to issue $3 million of bonds with a coupon rate of 8%. As inflation is causing interest rates
to rise above 8%:
A. The bonds will sell at a discount as the required rate of return devalues the bonds.
B. The face value of the bonds will decline.
C. The bonds will sell at a premium to compensate investors for the low stated rate.
D. The value of the bonds will be greater than their face value.
A financial manager usually prefers to issue preferred stock rather than debt because
A. The cost of fixed debt is less expensive since it is tax deductible even if a sinking fund is required to retire the debt.
B. Payments to preferred stockholders are not considered fixed payments.
C. In a legal sense, preferred stock is equity; therefore, dividend payments are not legal obligations.
D. The preferred dividend is often cumulative, whereas interest payments are not.
Question 24 - CMA 695 P1 Q9 - L-T Financial Management-Financial Instruments
In practice, dividends
A. fluctuate more widely than earnings.

B. usually exhibit greater stability than earnings.
C. are usually set as a fixed percentage of earnings.
D. tend to be a lower percentage of earnings for mature firms.
A publicly-traded corporation in an industry with an average price/earnings ratio of 20 has the following summary
financial results.
Sales $1,000,000
Expenses 500,000
Operating income $ 500,000
Taxes 300,000
Net income $ 200,000
Assets $2,500,000
Liabilities $1,000,000
Shareholders' equity$1,500,000
A competitor wishes to make a bid to acquire the stock of the company. What is the current market value?
A. $1,500,000.
B. $20,000,000.
C. $4,000,000.
D. $10,000,000.
A major use of warrants in financing is to
A. avoid dilution of earnings per share.

B. lower the cost of debt.
C. permit the buy-back of bonds before maturity.
D. maintain managerial control.
Question 27- CMA 695 1.8.5 Adapted - L-T Financial Management-Financial Instruments
Below is a Statement of Financial Position for Martin Corporation:

Martin Corporation
Statement of Financial Position
(Dollars in millions)
Assets:
Current Assets $ 75
Plant and Equipment 250
Total Assets $325
Liabilities and shareholders' equity:
Liabilities:
Current Liabilities $ 46
Long-term debt (12%) 64
Common equity:
Common stock, $1 par $ 10
Additional paid in capital 100
Retained earnings 105
Total liabilities and shareholders' equity $325
Additional Data:
The long term debt was originally issued at par ($1,000 per bond) and is currently trading at $1,250 per bond.
Martin Corporation can now issue debt at 150 basis points over U.S. treasury bonds.
The current risk-free rate (U.S. Treasury bonds) is 7%.
The expected market return is currently 15%.
The beta for Martin is 1.25.
Martin's effective corporate income tax rate is 40%.
Martin paid a dividend of $1.00 per share last year.
Martin's dividend is expected to grow at the rate of 5% per year.
What price should Martin's common stock sell for currently?
A. $8.33
B. $6.67
C. $8.75
D. $10.50
Below is a partial Statement of Financial Position for Monosone, Inc.:

Monosone, Inc.
December 31, Year 1
Total assets $10,000,000
Current liabilities $ 2,000,000

Long-term debt 3,000,000
Common stock (1,000,000 shares authorized,
500,000
100,000 shares outstanding at $5 par value)
Paid-in capital in excess of par 1,600,000
Retained earnings 2,900,000
Total liabilities and shareholder's equity $10,000,000
Expected dividend payments:
December 31, year 2 $2.00
Expected selling price on:
An investor is considering buying Monosone, Inc.'s common stock on January 1, year 2 and anticipates, with
reasonable assurance, selling it December 31, year 4 at $25.00 per share. What is the approximate intrinsic value on
January 1, year 2 of each share (rounded to the nearest dollar) when the required rate of return is 10%?
A. $19.
B. $24.
C. $31.
D. $30.
The common stock of a beverage company has a current market price of $34. The beverage company is estimated to
earn $2 per share in the next year. The average price/earnings ratio of companies in the beverage industry is 15.
Using the price/earnings ratio as the comparable valuation method, the beverage company’s stock is
A. $4 undervalued.
B. $2 overvalued.
C. $4 overvalued.
D. $2 undervalued.
A downward-sloping yield curve depicting the term structure of interest rates implies that:
A. Interest rates have declined over recent years.

B. Prevailing short-term interest rates are higher than prevailing long-term interest rates.
C. Interest rates have increased over recent years.
D. Prevailing short-term interest rates are lower than prevailing long-term interest rates.
A call provision in a bond indenture
A. allows the bondholder the option to buy shares of the company's common stock at a specified price within a
specified period.
B. requires the issuer to call in its bonds if interest rates rise above a predetermined level to allow bondholders the
opportunity for higher rates.
C. allows the issuer to call in the bonds before maturity, usually along with payment of an additional sum called a call
premium.
D. permits bondholders to call for additional bond issuances at predetermined intervals.
Dorsy Manufacturing plans to issue mortgage bonds subject to an indenture. Which of the following restrictions or
requirements are likely to be contained in the indenture?
I. Receiving the trustee's permission prior to selling the property.
II. Maintain the property in good operating condition.
III. Insuring plant and equipment at certain minimum levels.
IV. Including a negative pledge clause.
A. I, II, III and IV.

B. II and III only.
C. I, III, and IV only.
D. I and IV only.
Which of the following scenarios would encourage a company to use short-term loans to retire its 10-year bonds that
have 5 years until maturity?
A. Interest rates have increased over the last 5 years.

B. Interest rates have declined over the last 5 years.
C. The company is experiencing cash flow problems.
D. The company expects interest rates to increase over the next 5 years.
Which of the following brings in additional capital to the firm?
A. Exercise of warrants.
B. Conversion of convertible bonds to common stock.
C. Purchase of option through an option exchange.
D. Two-for-one stock split.
Debentures are
A. bonds secured by the full faith and credit of the issuing firm.
B. subordinated debt and rank behind convertible bonds.

C. a form of lease financing similar to equipment trust certificates.
D. income bonds that require interest payments only when earnings permit.
Question 36 - HOCK CFMQ6 - L-T Financial Management-Financial Instruments
A share has a market price of $50.00. It is expected to be able to pay a steady dividend of $2.50 per share each year
starting in one year's time. There will not be any growth in the dividend. If the investors' required rate of return
changes to 8%, the effect would be
A. the share price will go up to $62.50.

B. the share price will go down to $31.25.
C. there will be no change in either the dividend or the share price.
D. the dividend would increase to $4.00.
Question 37 - CMA 695 P1 Q13 - L-T Financial Management-Financial Instruments
The equity section of Smith Corporation's statement of financial position is presented below.
Preferred stock, $100 par $12,000,000
Common stock, $5 par 10,000,000
Paid-in capital in excess of par 18,000,000
Retained earnings 9,000,000
Net worth $49,000,000
The common shareholders of Smith Corporation have preemptive rights. If Smith Corporation issues 400,000
additional shares of common stock at $6 per share, a current holder of 20,000 shares of Smith Corporation's common
stock must be given the option to buy
A. 3,774 additional shares.

B. 3,333 additional shares.
C. 4,000 additional shares.
D. 1,000 additional shares.
Which one of the following statements concerning debt instruments is correct?
A. For long-term bonds, price sensitivity to a given change in interest rates is greater the longer the maturity of the
bond.
B. A 25-year bond with a coupon rate of 9% and one year to maturity has more interest rate risk than a 10-year bond
with a 9% coupon issued by the same firm with one year to maturity.
C. A bond with one year to maturity would have more interest rate risk than a bond with 15 years to maturity.
D. The coupon rate and yield of an outstanding long-term bond will change over time as economic factors change.

Preferred stock may be retired through the use of any one of the following except a
A. sinking fund.
B. conversion.
C. call provision.
D. refunding.
Which one of the following provides the best measure of interest rate risk for a corporate bond?
A. Yield to maturity.
B. Maturity.
C. Duration.
D. Bond rating.
Which one of the following is a debt instrument that generally has a maturity of ten years or more?
A. A chattel mortgage.
B. A financial lease.
C. A note.
D. A bond.
Which of the following is directly applied in determining the value of a stock when using the dividend growth model?
A. The investors' required rate of return on the firm's stock.

B. The firm's capital structure.
C. The firm's cash flows.
D. The firm's liquidity.
Protective clauses set forth in an indenture are known as
A. covenants.
B. provisions.
C. requirements.
D. addenda.
If a $1,000 bond sells for $1,125, which of the following statements are correct?
I. The market rate of interest is greater than the coupon rate on the bond.
II. The coupon rate on the bond is greater than the market rate of interest.
III. The coupon rate and the market rate are equal.
IV. The bond sells at a premium.
V. The bond sells at a discount.
A. I and IV.
B. II and IV.
C. I and V.
D. II and V.
A call provision
A. lowers the investors' required rate of return.

B. protects investors against margin calls.
C. allows bondholders to require the organization to retire the bond before original maturity.
D. provides an organization flexibility in financing if interest rates fall.
Question 46 - HOCK CFMQ5 - L-T Financial Management-Financial Instruments
A share has a market price of $2.50. It is expected to be able to pay a steady dividend of 30 cents per share each
year starting in one year's time. There will not be any growth in dividends. Other things being equal, if the expected
dividend goes up to 33 cents:
A. The share price would go down to $2.25.

B. The share price would go up to $2.75.
C. The share price would stay at $2.50.
D. The share price would go up to $2.53.
Question 47 - HOCK LTF 112 - L-T Financial Management-Financial Instruments
The current price of Mutts, Inc. stock is $30 per share, and during the current year, the stock paid a 5% dividend. The
stock’s beta is 1.2. The expected return to the market is 9%; and the risk-free rate is 3%. Mutts, Inc.'s cost of retained
earnings is 10.2%. What should the company’s next year’s dividend be?
A. $2.70 per share

B. $1.80 per share
C. $1.574 per share
D. $1.545 per share
What variable is measured on the horizontal axis of the yield curve?
A. Par value of the bonds.

B. Duration of the bonds.
C. Years to maturity of the bonds.
D. Yield of the bonds.
James Hemming, the chief financial officer of a midwestern machine parts manufacturer, is considering splitting the
company’s stock, which is currently selling at $80.00 per share. The stock currently pays a $1.00 per share dividend. If
the split is two-for-one, Mr. Hemming may expect the post split price to be
A. less than $40.00, regardless of dividend policy.

B. greater than $40.00, if the dividend is changed to $0.45 per new share.
C. exactly $40.00, regardless of dividend policy.
D. greater than $40.00, if the dividend is changed to $0.55 per new share.
Question 50 - HOCK RRI 100 - L-T Financial Management-Derivatives
The long party to a futures contract is
A. the party who has no choice but who must comply with the will of the other party to the contract.
B. the party who is committing to buy the underlying asset as a protection against a possible increasing price of the
actual asset.
C. the party who is committing to sell the underlying asset as a protection against a possible declining price of the
actual asset.
D. the party who has the choice to exercise or not exercise the contract.
Question 51 - CMA 696 1.9 - L-T Financial Management-Derivatives
The current market price of ActionPharmaceutical's common stock is $34. A 6-month call option has been written on
the stock. The option has an exercise price of $40 and a market value of $4. A financial analyst estimates that, at the
end of 6 months, the expected value of the stock is $42.
What is the theoretical value of exercising the option on the date it is written?
A. $6.00
B. $4.00
C. $8.00
D. $0
On July 14, an investor goes short on a call option for 100 shares of CDM Corporation common stock with a strike
price of $70.00, expiring on August 16, at an option premium of $3.00 per share. The market price of CDM on July 14
is $68.00. On August 16, the market price of CDM is $75.00. How much has the investor gained or lost on the option
transaction? Disregard any brokerage commissions involved.
A. Loss of $200.
B. $200 gain.
C. Loss of $500.
D. Gain of $300.
How is a futures contract closed out?
A. Buyers and sellers usually offset their positions on or before the delivery date.
B. The contract is returned to the party it was purchased from.
C. On the maturity date, the underlying asset is purchased and delivery taken, or sold and delivery made, by the
holder of the contract.
D. The contract expires on the maturity date, and there is no need to do anything to close it out.
On July 14, an investor goes long on a put option for 100 shares of ZXY Corporation common stock with a strike price
of $33.00, expiring on August 16, at an option premium of $1.25 per share. The market price of ZXY on July 14 is
$32.50. On August 16, the market price of ZXY is $35.00. How much has the investor gained or lost on the option
A. Loss of $125.
B. Gain of $250.
C. Loss of $175.
D. Gain of $125.
The difference between an American option and a European option is
A. a European option can be exercised only on its maturity date, whereas an American option can be exercised
anytime up to and including its expiration date.
B. a European option is binding on both parties, whereas the short party in an American option has the right but not
the obligation to exercise the option.
C. an American option is a covered option, whereas a European option is not.
D. a European option is binding on both parties, whereas the long party in an American option has the right but not the
obligation to exercise the option.
On July 14, an investor goes short on a call option for 100 shares of CDM Corporation common stock with a strike
price of $70.00, expiring on August 16, at an option premium of $3.00 per share. The market price of CDM on July 14
is $68.00. On August 16, the market price of CDM is $65.00. How much has the investor gained or lost on the option
A. Gain of $300.
B. Loss of $300.
C. Loss of $200.
D. Gain of $200.
On July 14, an investor goes long on a call option for 100 shares of AMB Corporation common stock with a strike price
of $27.00, expiring on August 16, at an option premium of $4.50 per share. The market price of AMB on July 14 is
$31.00. On August 16, the market price of AMB is $25.00. How much has the investor gained or lost on the option
A. Gain of $450.
B. Loss of $450.
C. Gain of $150.
D. Loss of $250.
On July 14, an investor goes long on a put option for 100 shares of ZXY Corporation common stock with a strike price
of $33.00, expiring on August 16, at an option premium of $1.25 per share. The market price of ZXY on July 14 is
$32.50. On August 16, the market price of ZXY is $30.00. How much has the investor gained or lost on the option
A. Gain of $300.
B. Loss of $175.
C. Gain of $175.
D. Gain of $75.
On July 14, an investor goes short on a put option for 100 shares of OSC, Inc. common stock with a strike price of
$9.00, expiring on August 16, at an option premium of $1.50 per share. The market price of OSC on July 14 is $8.00.
On August 16, the market price of OSC is $11.00. How much has the investor gained or lost on the option
A. Gain of $150.
B. Gain of $200.
C. Loss of $50.
D. Loss of $150.
All of the following statements about the intrinsic value of an option are true except
A. The intrinsic value of an option is the amount by which it is "in the money."
B. The intrinsic value of an option is equal to its market value.
C. The intrinsic value of an option is its value, before transaction costs, to an investor who would buy the option and
exercise it immediately.
D. The intrinsic value of an option is only one part of its market value.
Part 2 : Cost of Capital
Question 1 - CMA 1294 1.29 - Cost of Capital
Which one of the following factors might cause a firm to increase the debt in its financial structure?
A. An increase in the price-earnings (PE) ratio.

B. An increase in the corporate income tax rate.
C. Increased economic uncertainty.
D. An increase in the Federal funds rate.
Question 2 - ICMA 10.P2.137 - Cost of Capital
The management of Old Fenske Company (OFC) has been reviewing the company's financing arrangements. The
current financing mix is $750,000 of common stock, $200,000 of preferred stock ($50 par) and $300,000 of debt. OFC
currently pays a common stock cash dividend of $2. The common stock sells for $38, and dividends have been
growing at about 10% per year. Debt currently provides a yield to maturity to the investor of 12%, and preferred stock
pays a dividend of 9% to yield 11%. Any new issue of securities will have a flotation cost of approximately 3%. OFC
has retained earnings available for the equity requirement. The company's effective income tax rate is 40%. Based on
this information, the cost of capital for retained earnings is
A. 9.5%.
B. 16.0%.
C. 14.2%.
D. 15.8%.
Wiley's new financing will be in proportion to the market value of its present financing, shown below.
Book Value
($000 Omitted)
Long-term debt $7,000
Preferred stock (100 shares) 1,000
Common stock (200 shares) 7,000
The firm's bonds are currently selling at 80% of par, generating a current market yield of 9%, and the corporation has
a 40% tax rate. The preferred stock is selling at its par value and pays a 6% dividend. The common stock has a
current market value of $40 and is expected to pay a $1.20 per share dividend this fiscal year. Dividend growth is
expected to be 10% per year. Wiley's weighted average cost of capital is (round your calculations to tenths of a
percent).
A. 11.0%.
B. 9.0%.
C. 9.6%.
D. 10.8%.
In calculating the component costs of long-term funds, the appropriate cost of retained earnings, ignoring flotation
costs, is equal to
A. the weighted average cost of capital for the firm.

B. the same as the cost of preferred stock.
C. zero, or no cost.
D. the cost of common stock.
The explicit cost of debt financing is the interest expense. The implicit cost(s) of debt financing is (are) the
A. Increase in the cost of debt as the debt-to-equity ratio increases.

B. Increases in the cost of debt and equity as the debt-to-equity ratio increases.
C. Increase in the cost of equity as the debt-to-equity ratio decreases.
D. Decrease in the cost of equity as the debt-to-equity ratio increases.
DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following
combination of debt and equity to finance the investment.
Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs of 2% of par.
Use $35 million of funds generated from earnings.
The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient
for DQZ is estimated to be 0.60. DQZ is subject to an effective corporate income tax rate of 40%.
The before-tax cost of DQZ's planned debt financing, net of flotation costs, in the first year is
A. 7.92%
B. 11.80%
C. 8.08%
D. 10.00%
Question 7 - CFM Sample Q. 8 - Cost of Capital

- Bonds that would have a 9% coupon rate and would net $19.2 million after flotation costs
- Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
- Common stock that would yield $24 million after a 5% flotation cost
The second alternative would consist of a public offering of bonds that would have an 11% coupon rate and would net
$48 million after flotation costs.
Assuming the after-tax cost of common stock is 15%, the after-tax weighted marginal cost of capital for Rogers' first
financing alternative consisting of bonds, preferred stock, and common stock would be
A. 10.285%
B. 8.725%
C. 11.725%
D. 7.285%
By using the dividend growth model, estimate the cost of equity capital for a firm with a stock price of $30.00, an
estimated dividend at the end of the first year of $3.00 per share, and an expected growth rate of 10%.
A. 20.0%
B. 10.0%
C. 21.0%
D. 11.0%
A firm has $10 million in equity and $30 million in long-term debt to finance its operations. The firm’s beta is 1.125, the
risk-free rate is 6%, and the expected market return is 14%. The firm issued long-term debt at the market rate of 9%.
Assume the firm is at its optimal capital structure. The firm’s effective income tax rate is 40%. What is the firm’s
weighted average cost of capital?
A. 7.8%.
B. 10.5%.
C. 8.6%.
D. 9.5%.
A firm's target or optimal capital structure is consistent with which one of the following?
A. Minimum weighted average cost of capital.

B. Maximum earnings per share.
C. Minimum risk.
D. Minimum cost of debt.
The Hatch Sausage Company is projecting an annual growth rate for the foreseeable future of 9%. The most recent
dividend paid was $3.00 per share. New common stock can be issued at $36 per share. Using the constant growth
model, what is the approximate cost of capital for retained earnings?
A. 9.08%.
B. 18.08%
C. 19.88%.
D. 17.33%.
Question 12 - CIA 1191 IV.57 - Cost of Capital
A firm seeking to optimize its capital budget has calculated its marginal cost of capital and projected rates of return on
several potential projects. The optimal capital budget is determined by
A. Calculating the point at which marginal cost of capital meets the projected rate of return, assuming that the most
profitable projects are accepted first.
B. Calculating the point at which average marginal cost meets average projected rate of return, assuming the largest
projects are accepted first.
C. Accepting all potential projects with projected rates of return lower than the highest marginal cost of capital.
D. Accepting all potential projects with projected rates of return exceeding the lowest marginal cost of capital.
Joint Products Inc., a corporation with a 40% marginal tax rate, plans to issue $1,000,000 of 8% preferred stock in
exchange for $1,000,000 of its 8% bonds currently outstanding. The firm’s total liabilities and equity are equal to
$10,000,000. The effect of this exchange on the firm’s weighted average cost of capital is likely to be
A. a decrease, since preferred stock payments do not need to be made each year, whereas debt payments must be
made.
B. a decrease, since a portion of the debt payments are tax deductible.
C. an increase, since a portion of the debt payments are tax deductible.
D. no change, since it involves equal amounts of capital in the exchange and both instruments have the same rate.
A company is in the process of considering various methods of raising additional capital to grow the company. The
current capital structure is 25% debt totaling $5 million with a pre-tax cost of 10%, and 75% equity with a current cost
of equity of 10%. The marginal income tax rate is 40%. The company’s policy is to allow a total debt to total capital
ratio of up to 50% and a maximum weighted-average cost of capital (WACC) of 10%. The company has the following
options.
Option 1: Issue debt of $15 million with a pre-tax cost of 10%.

Option 2: Offer shares to the public to generate $15 million. The cost of equity is 10%.
Which option should the company select?
A. Option 2 because the equity to total capital ratio will be 86%.

B. Option 1 because the equity to total capital ratio will be 43%.
C. Option 1 because it has the lower WACC of 7.72%.
D. Either Option 1 or 2 because both will yield a WACC of 10%.
In general, it is more expensive for a company to finance with equity capital than with debt capital because
A. equity capital is in greater demand than debt capital.

B. investors are exposed to greater risk with equity capital.
C. the interest on debt is a legal obligation.
D. long-term bonds have a maturity date and must therefore be repaid in the future.
Kielly Machines Inc. is planning an expansion program estimated to cost $100 million. Kielly is going to raise funds
according to its target capital structure shown below.
Debt 0.30
Preferred stock0.24
Equity 0.46
Kielly had net income available to common shareholders of $184 million last year of which 75% was paid out in
dividends. The company has a marginal tax rate of 40%.
Additional data:
The before-tax cost of debt is estimated to be 11%.
The market yield of preferred stock is estimated to be 12%.
The after-tax cost of common stock is estimated to be 16%.
What is Kielly's weighted average cost of capital?
A. 14.00%.
B. 12.22%.
C. 13.00%.
D. 13.54%.
Question 17 - CFM Sample Q. 7 - Cost of Capital

Bonds that would have a 9% effective annual rate and would net $19.2 million after flotation costs
Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
Common stock that would yield $24 million after a 5% flotation cost
The second alternative would consist of a public offering of bonds that would have an 11% effective annual rate and
would net $48 million after flotation costs.
The after-tax cost of the common stock proposed in Rogers' first financing alternative would be
A. 16.60%
B. 17.16%
C. 16.00%
D. 16.53%
Williams, Inc. is interested in measuring its overall cost of capital and has gathered the following data. Under the terms
described as follows, the company can sell unlimited amounts of all instruments.
Williams can raise cash by selling $1,000, 8%, 20-year bonds with annual interest payments. In selling the
issue, an average premium of $30 per bond would be received, and the firm must pay flotation costs of $30 per
bond. The after-tax cost of funds is estimated to be 4.8%.
Williams can sell $8 preferred stock at par value, $100 per share. The cost of issuing and selling the preferred
stock is expected to be $5 per share.
Williams' common stock is currently selling for $100 per share. The firm expects to pay cash dividends of $7 per
share next year, and the dividends are expected to remain constant. The stock will have to be underpriced by
$3 per share, and flotation costs are expected to amount to $5 per share.
Williams expects to have available $100,000 of retained earnings in the coming year. Once these retained
earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.
The capital structure that Williams would like to use for any future financing is:
Long-term debt: 30%
Preferred stock: 20%
Common stock: 50%
If Williams, Inc. needs a total of $1,000,000, the firm's weighted marginal cost of capital would be
A. 6.9%.
B. 4.8%.
C. 6.6%.
D. 27.8%.
Question 19 - CIA 1195 IV.43 - Cost of Capital
When calculating the cost of capital, the cost assigned to retained earnings should be
A. Zero.
B. Equal to the cost of external common equity.
C. Higher than the cost of external common equity.
D. Lower than the cost of external common equity.

Thomas Company's capital structure consists of 30% long-term debt, 25% preferred stock, and 45% common equity.
The cost of capital for each component is shown below.
Long-term debt 8%
Preferred stock 11%
Common equity15%
If Thomas pays taxes at the rate of 40%, what is the company's after-tax weighted average cost of capital?
A. 11.90%.
B. 9.84%.
C. 10.94%.
D. 7.14%.
Osgood Products has announced that it plans to finance future investments so that the firm will achieve an optimum
capital structure. Which one of the following corporate objectives is consistent with this announcement?
A. Minimize the cost of debt.

B. Maximize earnings per share.
C. Maximize the net worth of the firm.
D. Minimize the cost of equity.
Below is a Statement of Financial Position for Martin Corporation:

Martin Corporation
(Dollars in millions)
Assets:
Current Assets $ 75
Plant and Equipment 250
Total Assets $325
Liabilities and shareholders' equity:
Liabilities:
Current Liabilities $ 46
Long-term debt (12%) 64
Common equity:
Common stock, $1 par $ 10
Additional paid in capital 100
Retained earnings 105
Total liabilities and shareholders' equity $325
Additional Data:
The long term debt was originally issued at par ($1,000 per bond) and is currently trading at $1,250 per bond.
Martin Corporation can now issue debt at 150 basis points over U.S. treasury bonds.
The current risk-free rate (U.S. Treasury bonds) is 7%.
The expected market return is currently 15%.
The beta for Martin is 1.25.

Martin's effective corporate income tax rate is 40%.
Using the Capital Asset Pricing Model (CAPM), Martin Corporation's current cost of common equity is:
A. 8.75%
B. 17.00%
C. 10.00%
D. 15.00%
DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following
combination of debt and equity to finance the investment.
Issue $15 million of 20-year bonds at 101, with a coupon rate of 8%, and flotation costs of 2% of par.
Use $35 million of funds generated from earnings.
The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient
for DQZ is estimated to be 0.60. DQZ is subject to an effective corporate income tax rate of 40%.
The capital asset pricing model (CAPM) computes the expected return on a security by adding the risk-free rate of
return to the incremental yield of the expected market return, which is adjusted by the company's beta. Compute
DQZ's expected rate of return.
A. 7.20%
B. 12.20%
C. 12.00%
D. 9.20%
The firm's marginal cost of capital
A. is unaffected by the firm's capital structure.

B. should be the same as the firm's rate of return on equity.
C. is a weighted average of the investors' required returns on debt and equity.
D. is inversely related to the firm's required rate of return used in capital budgeting.
Question 25 - HOCK RRI 111 - Cost of Capital
A negative beta means
A. that the security is risk-free.

B. that the security is less volatile than the market as a whole.
C. that the security's return is negative.
D. that the price of the security has tended to move in the opposite direction to that of the market.
Part 2 : Raising Capital
Question 26 - CMA 689 1.9 - Raising Capital
A sound justification for a firm's repurchase of its own stock, such as treasury stock, is to
A. increase the firm's total assets.

B. reduce the idle cash and increase marketable securities.
C. meet the stock needs of a potential merger.
D. lower the debt to equity ratio of the firm.
Question 27 - ICMA 1603.P2.021 - Raising Capital
The treasurer of a company plans to raise $500 million to finance its new business expansion into the Asia Pacific
region. The treasurer is analyzing initial public offerings. All of the following are correct except that
A. under an underwritten offering, the investment bank will guarantee the sale of stock at an offering price, however,
the commission charged to the company will be higher compared to a best efforts offering.
B. one of the advantages of an initial public offering is that stock price can accurately reflect the true net worth of the
company after it goes public.
C. an initial public offering will increase the liquidity of the company's stock and establish the company's value in the
market.
D. it is necessary for the company to file a registration statement with the SEC if it decides to launch an initial public
offering.
A firm's dividend policy may treat dividends either as the residual part of a financing decision or as an active policy
strategy.
Treating dividends as the residual part of a financing decision assumes that
A. Dividends are important to shareholders, any earnings left over after paying dividends should be invested in
high-return assets.
B. Earnings should be retained and reinvested as long as profitable projects are available.
C. Dividends are relevant to a financing decision.
D. Dividend payments should be consistent.
OldTime Inc. is a mature firm operating in a very stable market. Earnings growth has averaged about 3.2% for the last
dozen years, just staying in line with inflation. The firm’s weighted average cost of capital is 8%, much lower than most
firms'. John Storms has just been hired as OldTime’s new CEO and wants to turn what he calls a “cash cow” into a
“growth company.” Storms wants to reduce the dividend pay-out and use the resulting retained earnings to fund the
firm’s expansion into new product lines. OldTime’s historical beta has been about 0.6. With the CEO’s changes, what
will most likely happen to OldTime’s beta and the required return on investment in its shares?
A. The beta will rise and the required return will fall.
B. The beta will fall and the required return will fall.
C. The beta will fall and the required return will rise.
D. The beta will rise and the required return will rise.
Question 30 - CMA 693 P1 Q7 - Raising Capital
When a company desires to increase the market value per share of common stock, the company will
A. Sell treasury stock.

B. Implement a reverse stock split.
C. Sell preferred stock.
D. Split the stock.
The characteristics of venture capital include all of the following except
A. A lack of liquidity for a period of time.

B. Initial private placement for the majority of issues.
C. A minimum holding period of 5 years for new securities.
D. The use of common stock for most placements.
Question 32 - CIA 590 IV.48 - Raising Capital
The date when the right to a dividend expires is called the
A. Ex-dividend date.
B. Holder-of-record date.
C. Payment date.
D. Closing date.
Question 33 - CIA 1190 IV.52 - Raising Capital
An issue of securities for which the investment bank handling the transaction gives no guarantee that the securities
will be sold is a(n)
A. Best efforts issue.

B. Competitive bid issue.
C. Negotiated issue.
D. Underwritten issue.
Question 34 - CIA 593 P4 Q46 - Raising Capital
The policy decision that by itself is least likely to affect the value of the firm is the
A. Sale of a risky division that will now increase the credit rating of the entire company.
B. Distribution of stock dividends to shareholders.

C. Use of a more highly leveraged capital structure that resulted in a lower cost of capital.
D. Investment in a project with a large net present value.
A company can finance an equipment purchase through a loan. Alternatively, it often can obtain the same equipment
through a lease arrangement. A factor that would not be considered when comparing the lease financing with the loan
financing is:
A. Whether the lessor has a higher cost of capital than the lessee.
B. The capacity of the equipment.
C. Whether the property category has a history of rapid obsolescence.
D. Whether the lessor and lessee have different tax reduction opportunities.
Underhall Inc.’s common stock is currently selling for $108 per share. Underhall is planning a new stock issue in the
near future and would like to stimulate interest in the company. The Board, however, does not want to distribute
capital at this time. Therefore, Underhall is considering whether to offer a 2-for-1 common stock split or a 100% stock
dividend on its common stock. The best reason for opting for the stock split is that
A. the impact on earnings per share will not be as great.

B. the par value per share will remain unchanged.
C. it will not impair the company's ability to pay dividends in the future.
D. it will not decrease shareholders' equity.
Question 37 - CMA 689 P1 Q7 - Raising Capital
A stock dividend
A. decreases future earnings per share.

B. increases the debt-to-equity ratio of a firm.
C. increases shareholders' wealth.
D. decreases the size of the firm.
When determining the amount of dividends to be declared, the most important factor to consider is the
A. impact of inflation on replacement costs.

B. expectations of the shareholders.
C. future planned uses of cash.
D. future planned uses of retained earnings.
A 10% stock dividend most likely
A. increases shareholders' wealth.

B. decreases future earnings per share.
C. decreases net income.
D. increases the size of the firm.
The residual theory of dividends argues that dividends
A. are irrelevant.
B. are necessary to maintain the market price of the common stock.
C. can be foregone unless there is an excess demand for cash dividends.
D. can be paid if there is income remaining after funding all attractive investment opportunities.

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Part 2 : Financial Instruments

Question 1 - HOCK RRI 9 - Risk and Return

An efficient portfolio is a portfolio that is in the feasible set of portfolios and

Question 2 - HOCK RRI 96 - Risk and Return

A. The beta coefficient measures non-market risk.

Question 3 - ICMA 1603.P2.073 - Risk and Return

A. beta of the company's stock decreases.

Question 4 - HOCK CMA P2 SDV3 - Risk and Return

Question 5 - HOCK RRI 98 - Risk and Return

Question 6 - ICMA 10.P2.113 - Risk and Return

Question 7 - HOCK CMA P2 SDV1 - Risk and Return

What is the expected market rate of return?

Question 8 - CIA 1191 IV.60 - Risk and Return

Question 9 - HOCK RRI 8 - Risk and Return

What kind of risk can be eliminated by diversification in a portfolio?

Question 10 - HOCK RRI 99 - Risk and Return

The beta coefficient for the market as a whole

Question 11 - CMA 697 1.11 - Risk and Return

Question 12 - ICMA 1603.P2.072 - Risk and Return

A. half the risk premium on the market.

Question 13 - CIA 589 IV.49 - Risk and Return

Question 14 - ICMA 10.P2.110 - Risk and Return

The systematic risk of an individual security is measured by the

A. standard deviation of the security's returns and other similar securities.

Question 15 - ICMA 01.P2.127 - L-T Financial Management-Financial Instruments

A. Preferred stock typically has no maturity date.

Question 16 - ICMA 10.P2.126 - L-T Financial Management-Financial Instruments

All of the following are characteristics of preferred stock except that

A. it may be callable at the option of the corporation.

Question 17 - CFM Sample Q. 10 - L-T Financial Management-Financial Instruments

The first alternative would consist of

A. The combination alternative carries the risk of increasing dividend payments.

Question 18 - CMA 695 1.2 - L-T Financial Management-Financial Instruments

A. A call provision is generally considered detrimental to the investor.

Question 19 - CMA 1288 1.7 - L-T Financial Management-Financial Instruments

Question 20 - CMA 689 1.4 - L-T Financial Management-Financial Instruments

Question 21 - CIA 592 IV.48 - L-T Financial Management-Financial Instruments

A. Current market value of the firm.

Question 22 - CMA 689 1.1 - L-T Financial Management-Financial Instruments

Question 23 - CMA 1288 1.9 - L-T Financial Management-Financial Instruments

Question 24 - CMA 695 P1 Q9 - L-T Financial Management-Financial Instruments

A. fluctuate more widely than earnings.

Question 25 - ICMA 13.P2.070 - L-T Financial Management-Financial Instruments

Question 26 - CMA 1291 1.6 - L-T Financial Management-Financial Instruments

A major use of warrants in financing is to

A. avoid dilution of earnings per share.

D. maintain managerial control.

Below is a Statement of Financial Position for Martin Corporation:

What price should Martin's common stock sell for currently?

Question 28 - CMA 688 1.7 - L-T Financial Management-Financial Instruments

Below is a partial Statement of Financial Position for Monosone, Inc.:

Current liabilities $ 2,000,000

Question 29 - ICMA 1603.P2.063 - L-T Financial Management-Financial Instruments

Question 30 - CIA 1192 IV.47 - L-T Financial Management-Financial Instruments

A. Interest rates have declined over recent years.

Question 31 - CIA 589 IV.56 - L-T Financial Management-Financial Instruments

A call provision in a bond indenture

Question 32 - ICMA 10.P2.119 - L-T Financial Management-Financial Instruments