FAC Corporate Finance & Investment 2

Question 1

A firm has a debt-to-equity ratio of 1.5 and an equity beta of 1.8. Using the Hamada equation, what is the asset (unlevered) beta if the tax rate is 30%?

Accepted Answer

0.86

Answer

Asset beta = Equity beta / [1 + (1 - tax rate) × D/E] = 1.8 / [1 + 0.70 × 1.5] = 1.8 / 2.05 ≈ 0.88, closest to 0.86.

Question 2

Which of the following best describes the concept of economic value added (EVA)?

Accepted Answer

NOPAT minus the dollar cost of all capital employed

Answer

EVA = NOPAT − (WACC × Invested Capital), measuring whether a firm earns above its cost of capital.

Question 3

A company is evaluating a project with an initial outlay of $500,000 and uneven cash flows. The IRR is 14% while WACC is 12%. The modified IRR (MIRR) is 11%. Which decision rule should be followed?

Accepted Answer

Reject because MIRR < WACC

Answer

MIRR is the more reliable measure; since MIRR (11%) < WACC (12%), the project destroys value and should be rejected.

Question 4

Under the pecking order theory of capital structure, firms prefer financing in which sequence?

Accepted Answer

Internal funds → Debt → Equity

Answer

Pecking order theory holds that firms use retained earnings first, then debt, and issue equity only as a last resort to minimize adverse selection costs.

Question 5

A callable bond is trading at a premium. How does the call feature most likely affect the bond's duration compared to an otherwise identical non-callable bond?

Accepted Answer

Duration is shorter because the call caps price appreciation and shortens expected maturity

Answer

Callable bonds exhibit negative convexity at premium prices; the call option caps price gains and effectively shortens duration.

(FAC) Finance and Accounting Certification Practice Test

(FAC) Finance and Accounting Certification Practice Test

FAC Corporate Finance & Investment 2