CA Financial Management 4 β Questions and Answers
Question 1: Under the Capital Asset Pricing Model (CAPM), the expected return of a stock with a beta of 1.5, a risk-free rate of 3%, and a market return of 9% is:
- 10.5%
- 12.0% (Correct answer)
- 13.5%
- 15.0%
Correct answer: 12.0%
E(R) = Rf + Ξ² Γ (Rm β Rf) = 3% + 1.5 Γ (9% β 3%) = 3% + 9% = 12%.
Question 2: A company repurchases its own shares. Which of the following is the most likely immediate balance sheet effect?
- Total assets increase and stockholders' equity increases
- Total assets decrease and stockholders' equity decreases (Correct answer)
- Total liabilities increase and total assets remain unchanged
- Retained earnings increase and cash decreases
Correct answer: Total assets decrease and stockholders' equity decreases
A buyback uses cash (reducing assets) and increases treasury stock (a contra-equity account), reducing stockholders' equity by the same amount.
Question 3: Which of the following is the primary goal of financial management for a publicly traded corporation?
- Maximizing total revenues
- Maximizing earnings per share in the current period
- Maximizing the market value of shareholders' wealth (Correct answer)
- Minimizing the firm's tax liability
Correct answer: Maximizing the market value of shareholders' wealth
The primary goal of financial management is to maximize shareholder wealth, reflected in the market price of the firm's stock, which accounts for risk and time value of money.
Question 4: An investor holds a portfolio with a beta of 0.8. If the market drops 10%, what is the expected portfolio return based on beta alone?
- β10%
- β8% (Correct answer)
- β6%
- β4%
Correct answer: β8%
A beta of 0.8 means the portfolio moves 80% as much as the market; a β10% market move implies a β8% portfolio move.
Question 5: The 'pecking order theory' of capital structure suggests that firms prefer financing in which order?
- Debt β equity β retained earnings
- Equity β debt β retained earnings
- Retained earnings β debt β equity (Correct answer)
- Retained earnings β equity β debt
Correct answer: Retained earnings β debt β equity
Pecking order theory (Myers & Majluf) holds that firms prefer internal financing first (retained earnings), then debt, and finally new equity to minimize information asymmetry costs.
Question 6: Which of the following best defines 'economic value added' (EVA)?
- Net income minus preferred dividends
- EBIT multiplied by (1 minus the tax rate)
- Net operating profit after tax minus the dollar cost of capital employed (Correct answer)
- Free cash flow divided by the number of shares outstanding
Correct answer: Net operating profit after tax minus the dollar cost of capital employed
EVA = NOPAT β (WACC Γ Invested Capital), measuring whether a firm earns more than the opportunity cost of the capital it uses.
Question 7: A firm with net income of $200,000, depreciation of $50,000, an increase in accounts receivable of $30,000, and an increase in accounts payable of $10,000 would report operating cash flow of:
- $220,000
- $230,000 (Correct answer)
- $240,000
- $260,000
Correct answer: $230,000
OCF = Net income + Depreciation β ΞAR + ΞAP = $200,000 + $50,000 β $30,000 + $10,000 = $230,000.
CA Financial Management 4
Under the Capital Asset Pricing Model (CAPM), the expected return of a stock with a beta of 1.5, a risk-free rate of 3%, and a market return of 9% is: