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IIA CIA Exam
Certified Internal Auditor Exam (Page 21 )

Updated On: 12-Jan-2026
Page 21 of 342
PDF with 1702 Questions

An entity must select from among several methods of financing arrangements when meeting its capital requirements. To acquire additional growth capital while attempting to maximize earnings per share, an entity should normally

  1. Attempt to increase both debt and equity in equal proportions, which presences a stable capital structure and maintains investor confidence.
  2. Select debt over equity initially, even though increased debt is accompanied by interest costs and a degree of risk.
  3. Select equity over debt initially, which minimizes risk and avoids interest costs.
  4. Discontinue dividends and use current cash flow, which avoids the cost and risk of increased debt and the dilution of EPS through increased equity.

Answer(s): B

Explanation:

Earnings per share will ordinarily be higher if debt is used to raise capital instead of equity, provided that the entity is not over-leveraged. The reason is that the cost of debt is lower than the cost of equity because interest is tax deductible. However, the prospect of higher EPS is accompanied by greater risk to the entity resulting from required interest costs, creditors' liens on the entity's assets, and the possibility of a proportionately lower EPS if sales volume fails to meet projections.



An entity has 10.000 outstanding shares with a market value of US $25 each. It just paid a US $1 per share dividend. Dividends are expected to grow at a constant rate of 10%. If flotation costs are 5% of the selling price, the cost of new equity financing is calculated by the following formula.

  1. Option A
  2. Option B
  3. Option C
  4. Option D

Answer(s): C

Explanation:

The cost of new equity is calculated by adding the expected dividend yield, based on the net proceeds of the new issue, to the expected dividend growth rate. The expected dividend at the end of the period equals the dividend at time zero times one plus the expected dividend growth rate. Net proceeds received by the entity when issuing one ordinary share equals the market price of a share times one minus the flotation cost percentage. Flotation costs include items such as underwriting fees. printing, and advertising. The calculation of the cost of new equity is as follows:



The marginal cost of debt for an entity is defined as the interest rate on <List A> debt minus

  1. Option A
  2. Option B
  3. Option C
  4. Option D

Answer(s): C

Explanation:

The marginal cost of debt as a rate) must equal the cost of new debt as a rate) minus the tax savings as a rate). Hence, marginal cost equals the cost of new debt times one minus the marginal tax rate, or ks(1 - T). This expression equals Ka ­ KaT. The marginal cost of debt financing is the interest rate on new debt minus the entity's marginal tax rate multiplied by the interest rate. Moreover, the marginal or incremental cost of debt to the entity is based on the cost of newly issued debt, not on the cost of outstanding debt.



The entity should invest in Project(s) <List A> and has an optimal capital budget of <List B> million.

  1. Option A
  2. Option B
  3. Option C
  4. Option D

Answer(s): B

Explanation:

The inf.-, reaction of the IOS and MCC schedules determines the cost of capital and the optimal capital budget. The entity should begin with the project having the highest return and continue accepting projects as long as the IRR the MCC. The highest ranked project is A, with a $50 million cost and a 14% IRR. The MCC is only 6% over this range of financing. The next highest ranked project is B, with a US $75 million cost and a 12% IRR. When US $125 million has been invested, the marginal cost of the next unit of capital is 10%, so Project B. is also acceptable, bringing the optimal capital budget to US $125 million. Project C is not acceptable because it has an 8% return. The MCC is 10% for the first US $50 million invested in this project and 12% for the remaining US $75 million.



The investment opportunity schedule IOS) shows. in rank order, how much money the entity would invest at different rates of return. Such schedules can be drawn only for a set of projects that:

  1. Have the same investment cost.
  2. Are mutually exclusive.
  3. Have the same net present value.
  4. Are independent.

Answer(s): D

Explanation:

An IOS schedule is drawn for a set of independent projects. The decision to be made is whether to accept or reject each project without regard to other investment opportunities. Thus, the cash flows of one independent project are not influenced by those of another. Independence should be distinguished from mutual exclusivity. Projects are mutually exclusive if acceptance of one requires rejection of the other. An entity has the following three investment projects available:



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