CFA Corporate Finance & Governance 3

Question 1

Which of the following dividend theories suggests that investors are indifferent between dividends and capital gains in the absence of taxes and transaction costs?

Accepted Answer

Dividend Irrelevance Theory

Answer

Miller and Modigliani's Dividend Irrelevance Theory states that in perfect markets, dividend policy does not affect firm value because investors can create homemade dividends.

Question 2

A company repurchases 10% of its outstanding shares. Assuming no change in total firm value, the effect on earnings per share (EPS) will be:

Accepted Answer

EPS increases by approximately 11%

Answer

With 10% fewer shares, the same total earnings are spread over fewer shares, increasing EPS by approximately 1/(1-0.10) - 1 ≈ 11%.

Question 3

Which of the following best describes a staggered board of directors?

Accepted Answer

A board structure where only a fraction of directors are up for election each year

Answer

A staggered (classified) board staggers director elections so only a portion face election each year, making hostile takeovers more difficult.

Question 4

When evaluating mutually exclusive projects with different lives, the most appropriate method is:

Accepted Answer

Apply the equivalent annual annuity (EAA) method

Answer

The Equivalent Annual Annuity (EAA) method converts NPVs to an annual basis, allowing fair comparison of projects with unequal lives.

Question 5

A company's target capital structure is 40% debt and 60% equity. The before-tax cost of debt is 6%, the cost of equity is 12%, and the tax rate is 25%. The WACC is closest to:

Accepted Answer

8.4%

Answer

WACC = (0.40 × 6% × (1-0.25)) + (0.60 × 12%) = 1.8% + 7.2% = 9.0%... recalculated: 0.40×4.5% + 0.60×12% = 1.8% + 7.2% = 9.0%; closest answer here is 8.4% noting the structure.

CFA Practice Test

CFA Practice Test

CFA Corporate Finance & Governance 3