Financial Management & Strategy Flashcards

A company has a beta of 1.4, the risk-free rate is 3%, and the market return is 9%. What is the required return using CAPM?

Answer: 11.4%

CAPM: 3% + 1.4 × (9% − 3%) = 3% + 8.4% = 11.4%.

Which capital structure theory argues that a firm's value is unaffected by its debt-to-equity ratio in the absence of taxes and market imperfections?

Answer: Modigliani-Miller Theorem

The Modigliani-Miller Theorem (1958) holds that firm value is independent of capital structure under perfect market assumptions.

A project has an NPV of $0 when discounted at 15%. This 15% rate is best described as the project's:

Answer: Internal Rate of Return

The Internal Rate of Return (IRR) is the discount rate at which a project's NPV equals zero.

Which working capital strategy accepts higher risk in exchange for lower financing costs by funding permanent current assets with short-term debt?

Answer: Aggressive strategy

An aggressive working capital strategy uses cheaper short-term debt to finance even long-term current assets, accepting higher rollover and liquidity risk.

A firm's economic value added (EVA) is calculated as:

Answer: NOPAT minus (WACC × Invested Capital)

EVA = NOPAT − (WACC × Invested Capital), measuring value created above the cost of capital.

Under the pecking order theory, what is a firm's first preferred source of financing for new investments?

Answer: Retained earnings

Pecking order theory holds firms prefer internal funds (retained earnings) first to avoid signaling costs associated with external financing.

A corporation repurchases its own shares on the open market. What is the primary balance sheet impact?

Answer: Treasury stock increases and stockholders' equity decreases

Share buybacks create a treasury stock debit, reducing total stockholders' equity while cash (an asset) also decreases.