CFC Financial Management & Strategy 4 — Questions and Answers
Question 1: A company issues $10 million in bonds at a 6% coupon when its tax rate is 25%. What is the after-tax cost of this debt?
- 4.5% (Correct answer)
- 6.0%
- 7.5%
- 3.0%
Correct answer: 4.5%
After-tax cost of debt = 6% × (1 − 0.25) = 4.5%, reflecting the tax shield on interest payments.
Question 2: Which financial strategy is most consistent with maximizing long-term shareholder value?
- Investing in all projects with positive NPV (Correct answer)
- Maximizing quarterly EPS growth
- Minimizing total debt on the balance sheet
- Maximizing gross revenue regardless of profitability
Correct answer: Investing in all projects with positive NPV
Accepting all positive-NPV projects directly increases the intrinsic value of the firm, which is the foundation of shareholder wealth maximization.
Question 3: A controller notices that a division's ROIC consistently falls below WACC. This indicates the division is:
- Destroying economic value (Correct answer)
- Creating economic value
- Generating excess free cash flow
- Operating at its breakeven point
Correct answer: Destroying economic value
When ROIC < WACC, each dollar invested earns less than it costs, destroying shareholder value and producing negative EVA.
Question 4: Which scenario best describes a natural hedge in foreign currency risk management?
- Matching foreign currency revenues with foreign currency expenses in the same currency (Correct answer)
- Purchasing currency options on an exchange
- Using a forward contract to lock in an exchange rate
- Borrowing in the domestic currency and converting proceeds
Correct answer: Matching foreign currency revenues with foreign currency expenses in the same currency
A natural hedge offsets currency risk by matching inflows and outflows in the same foreign currency, eliminating net exposure without derivatives.
Question 5: Under the Gordon Growth Model, a stock's intrinsic value increases if:
- The dividend growth rate increases, holding all else constant (Correct answer)
- The required rate of return increases
- Dividends are eliminated
- The payout ratio decreases without affecting growth
Correct answer: The dividend growth rate increases, holding all else constant
In the Gordon Growth Model (P = D1 / (r − g)), a higher growth rate (g) reduces the denominator, increasing the calculated intrinsic value.
Question 6: A company with a high degree of financial leverage will experience:
- Greater variability in EPS relative to changes in EBIT (Correct answer)
- Lower interest expense in absolute terms
- Reduced business risk due to fixed obligations
- Smaller swings in operating income
Correct answer: Greater variability in EPS relative to changes in EBIT
Financial leverage amplifies the effect of EBIT changes on EPS because fixed interest charges create a multiplier effect on earnings per share.
Question 7: In scenario analysis for capital budgeting, a financial controller typically evaluates:
- NPV under best-case, base-case, and worst-case assumptions simultaneously (Correct answer)
- Only the most likely outcome to avoid analysis paralysis
- Sensitivity of NPV to a single variable at a time
- Monte Carlo simulation across thousands of random variable combinations
Correct answer: NPV under best-case, base-case, and worst-case assumptions simultaneously
Scenario analysis examines multiple input variables changing together across defined scenarios (optimistic, base, pessimistic) to gauge the range of outcomes.
CFC Financial Management & Strategy 4
A company issues $10 million in bonds at a 6% coupon when its tax rate is 25%.
What is the after-tax cost of this debt?