CPFM Corporate Valuation Methods 4

Question 1

The weighted average cost of capital (WACC) weights the cost of debt and equity by their:

Accepted Answer

Market value proportions in the capital structure

Answer

WACC uses the market-value weights of debt and equity in the capital structure.

Question 2

Why is the cost of debt multiplied by (1 − tax rate) in the WACC formula?

Accepted Answer

Interest expense is tax-deductible, providing a tax shield

Answer

Interest is deductible, so the after-tax cost of debt is lower than the stated rate.

Question 3

The Capital Asset Pricing Model (CAPM) estimates the cost of equity as:

Accepted Answer

Risk-free rate + beta × equity risk premium

Answer

CAPM adds a beta-scaled equity risk premium to the risk-free rate.

Question 4

A firm with a beta of 1.5 is expected to be:

Accepted Answer

More volatile than the overall market

Answer

A beta above 1.0 indicates greater systematic risk and volatility than the market.

Question 5

All else equal, increasing the proportion of low-cost debt in the capital structure will generally:

Accepted Answer

Lower WACC up to a point, then raise it as financial risk grows

Answer

More cheap debt initially lowers WACC, but excessive leverage eventually raises costs through financial distress risk.

CPFM Practice Test