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Test Prep CFA-Level-I Exam
CFA® Level I Chartered Financial Analyst (Page 11 )

Updated On: 26-Jan-2026
Page 11 of 793
PDF with 3963 Questions

A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the marginal weighted average cost of capital when the capital budget is $40,000.
k(d) (interest rate on the firm's new date) = 10%
Net income = $40,000
Payout ratio = 50%
Tax rate = 40%
P(0) = $25
Growth = 0%
Shares outstanding = 10,000 Flotation cost on additional equity = 15%

  1. 13.69%
  2. 11.81%
  3. 8.05%
  4. 14.28%
  5. 7.20%

Answer(s): C

Explanation:

First, find the amount of equity and debt needed for a $40,000 budget:
Debt = 0.4 x $40,000 = $16,000; Equity = 0.6 x $40,000 = $24,000.
We can find the amount of retained earnings = Net Income(1 - Payout ratio), or RE = $40,000 x 0.5 = $20,000.
We will need to find the cost of new common equity, because we have only $20,000 of equity on hand, and we need $4,000 more!
Find the dividend, Do = [(0.5) $40,000]/# of Shares = $20,000/10,000 = $2.00.
Then, find the cost of new equity: k(e) = D1/[P0(1 - F)] + g = $2.00/[$25(1 - 0.15)] + 0% = 0.0941 = 9.41%.
Finally, calculate WACC, using k(e) = 0.0941, and k(d) = 0.10, so WACC = (D/A)(1 - Tax rate)k(d) + (E/A)k(e)
WACC = 0.4(1 - 0.4)(0.10) + 0.6(0.0941) = 0.0805, or 8.05%.



Which of the following statements is most correct?

  1. None of the statements are correct.
  2. When choosing between mutually exclusive projects, managers should accept all projects with IRRs greater than the weighted average cost of capital.
  3. Multiple IRRs can occur in cases when project cash flows are normal, but they are more common in cases where project cash flows are nonnormal.
  4. All of the statements are correct.
  5. One of the disadvantages of choosing between mutually exclusive projects on the basis of the discounted payback method is that you might choose the project with the faster payback period but with the lower total return.

Answer(s): E

Explanation:

The payback and discounted payback methods both ignore cash flows that are paid or received after the payback period. Concerning the other statements: Multiple IRRs can occur only for projects with nonnormal cash flows. Mutually exclusive projects implies that only one project should be chosen. The project with the highest NPV should be chosen.



Which of the following equations correctly illustrates the calculation of the cost of equity using the Bond-Yield- plus-Risk-Premium approach?

  1. Required rate of return on outstanding debt + subjective risk premium
  2. Before-tax yield on outstanding debt + subjective risk premium
  3. None of these answers
  4. After-tax cost of debt + subjective risk premium
  5. Annual dividend/current stock price + subjective risk premium
  6. Yield to maturity on outstanding long-term debt + subjective risk premium

Answer(s): F

Explanation:

The Bond-Yield-plus-Risk-Premium approach is a rather ad hoc method used by financial managers to determine the cost of common equity. Under this approach, a subjective risk premium is added to the yield to maturity of the firm's outstanding long-term debt. Typically, senior debt is used when possible, however, due to the ad hoc nature of this approach, there is abounding room for flexibility. This large degree of flexibility both adds to and detracts from the attractiveness of Bond-Yield-plus-Risk-Premium approach.



Ace Consulting, a multinational corporate finance consulting firm, is examining the data storage division of Intelligent Semiconductor Company. In order to evaluate the proposed expansion of this division, Ace Consulting is trying to determine its beta. In their analysis, Ace Consulting regresses the monthly return on assets for the data storage division against the average return on assets for the data storage index, a division of the S&P 100. Which of the following techniques most correctly describes this method of identifying individual project betas?

  1. Regression analysis
  2. Scenario analysis
  3. Pure-play method
  4. Situation analysis
  5. Monte Carlo simulation
  6. Accounting Beta method

Answer(s): F

Explanation:

In this example, Ace Consulting is employing the Accounting Beta method to determine the beta of the data storage division of Intelligent Semiconductor. This technique is often used when "pure play" firms cannot be found, or when a more empirical, "firm-specific" analysis is desired. "Monte Carlo simulation, situation analysis," and "scenario analysis" are all techniques for measuring stand-alone risk. While "regression analysis" is an attractive choice, it does not represent the best possible answer.



Which of the following statements is most correct?

  1. When comparing two projects, the project with the higher IRR will also have the higher MIRR.
  2. Both IRR and MIRR can produce multiple rates of return.
  3. The modified internal rate of return (MIRR) of a project increases as the cost of capital increases.
  4. All of these statements are correct.
  5. The internal rate of return (IRR) of a project increases as the cost of capital increases.

Answer(s): C

Explanation:

The MIRR is dependent on the cost of capital. As the cost of capital increases, so does the terminal value.
Because the MIRR is the rate, which equates the PV with the terminal value, the MIRR increases as the terminal value increases.



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