CFC Financial Management & Strategy 2 — Questions and Answers
Question 1: 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?
- 11.4% (Correct answer)
- 12.6%
- 9.0%
- 10.2%
Correct answer: 11.4%
CAPM: 3% + 1.4 × (9% − 3%) = 3% + 8.4% = 11.4%.
Question 2: 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?
- Modigliani-Miller Theorem (Correct answer)
- Pecking Order Theory
- Trade-Off Theory
- Agency Cost Theory
Correct answer: Modigliani-Miller Theorem
The Modigliani-Miller Theorem (1958) holds that firm value is independent of capital structure under perfect market assumptions.
Question 3: A project has an NPV of $0 when discounted at 15%. This 15% rate is best described as the project's:
- Internal Rate of Return (Correct answer)
- Weighted Average Cost of Capital
- Hurdle Rate
- Cost of Equity
Correct answer: Internal Rate of Return
The Internal Rate of Return (IRR) is the discount rate at which a project's NPV equals zero.
Question 4: Which working capital strategy accepts higher risk in exchange for lower financing costs by funding permanent current assets with short-term debt?
- Aggressive strategy (Correct answer)
- Conservative strategy
- Matching strategy
- Hedging strategy
Correct 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.
Question 5: A firm's economic value added (EVA) is calculated as:
- NOPAT minus (WACC × Invested Capital) (Correct answer)
- Net Income minus Dividends
- EBIT minus Interest Expense
- Operating Cash Flow minus Capital Expenditures
Correct answer: NOPAT minus (WACC × Invested Capital)
EVA = NOPAT − (WACC × Invested Capital), measuring value created above the cost of capital.
Question 6: Under the pecking order theory, what is a firm's first preferred source of financing for new investments?
- Retained earnings (Correct answer)
- Debt issuance
- Preferred stock
- Common equity issuance
Correct answer: Retained earnings
Pecking order theory holds firms prefer internal funds (retained earnings) first to avoid signaling costs associated with external financing.
Question 7: A corporation repurchases its own shares on the open market. What is the primary balance sheet impact?
- Treasury stock increases and stockholders' equity decreases (Correct answer)
- Total assets increase and liabilities decrease
- Retained earnings increase and cash increases
- Common stock par value decreases proportionally
Correct 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.
CFC Financial Management & Strategy 2
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?