CFA一级百题预测企业理财

4.
Corporate Issuers
4.1. Business Structure
4.1.1.
4.1.1.1. Sole Proprietorship

➢ In a sole proprietorship, the owner personally funds the capital needed to operate
the business and retains full control over the operations of the business while
participating fully in the financial returns and risks of the business.
◼ An example of a sole proprietorship is a family-owned store.
➢ Key features of sole proprietorships include the following
◼ No legal identity; considered extension of owner.
◼ Owner-operated business.
◼ Owner retains all return and assumes all risk.
◼ Profits from business taxed as personal income.
◼ Operational simplicity and flexibility.
◼ Financed informally through personal means.
◼ Business growth is limited by owner’s ability to finance and personal risk
appetite.
4.1.1.2. General Partnership
➢ A general partnership has two or more owners called partners whose roles and
responsibilities in the business are outlined in a partnership agreement.
◼ Examples: professional services businesses (e.g., law, accounting, medicine)
and small financial or financial advisory firms.
➢ Key features of general partnerships include the following
◼ No legal identity; partnership agreement sets ownership
◼ Partner-operated business
◼ Partners share all risk and business liability
◼ Partners share all return, with profits taxed as personal income
◼ Contributions of capital and expertise by partners
◼ Business growth is limited by partner resourcing capabilities and risk appetite
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4.1.1.3. Limited Partnership

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➢ A limited partnership (E.g. Private Equity)

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◼ At least one general partner with unlimited liability who is responsible for the
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management of the business.

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◼ Limited partners, have limited liability: they can lose only up to the amount of
their investment.
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此预测为考点预测，考题仅为复习参考
内部使用资料，严禁传播，否则追究法律责任
4.1.1.4. Corporation
➢ Owners in a corporation (and US LLC) have limited liability;
◼ Preferred form for larger companies and the dominant business structure
globally by revenues and asset values.
◼ Examples: national or multinational conglomerates, global asset managers,
and regional stock exchanges.
➢ Nonprofit organizations (i.e. nonprofit corporations (nonprofits)): Corporations
are formed with the specific purpose of promoting a public benefit, religious benefit,
or charitable mission.
◼ E.g. private foundations, Harvard University, Ascension, and the Asian
Development Bank.
➢ Key features of nonprofit
◼ Non-profits do not have shareholders and do not distribute dividends.
◼ Non-profits typically are exempt from paying taxes.
◼ If they are run well, non-profits can generate profits; however, all profits must
be reinvested in promoting the mission of the organization.
➢ Corporation: For-profits
◼ 1. Legal Identity
◆ A corporation is considered a legal entity separate and distinct from its
owners.
◼ 2. Owner–Operator Separation
◆ A key feature of most corporations is the separation between the owners,
and those who operate it, as represented by the board of directors and
company management.
◼ 3. Business liability
◆ In a corporation, risk is shared across all owners and owners have limited
liability.
◆ Corporations can raise two types of capital: ownership capital (equity)
and borrowed capital (debt).
◼ 4. Taxation: double taxation
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◆ In most countries, corporations are taxed directly on their profits.

◆ In many countries, shareholders pay an additional tax on distributions
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(dividends) that are passed on to them.

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➢ Key Features of Corporation

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◼ Separate legal identity

◼ Owner–operator separation allowing for greater, more diverse resourcing with
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some risk control
◼ Business liability is shared across multiple, limited liability owners with claims
to return and financial risk of their equity investment
◼ Shareholder tax disadvantage in countries with double taxation
◼ Distributions (dividends) taxed as personal income
◼ Unbounded access to capital and unlimited business potential
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4.1.2.
Q-1. Which of the following are not shared similarities among the four major business
structure types? p614 knowledge check
A. Sole proprietorships and general partnerships lack legal identity.

B. Corporate shareholders and general partners have limited liability.
C. The taxation of sole proprietorships and limited partnerships is comparable.
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4.2. Public and Private corporation
4.2.1.
4.2.1.1. Public vs. Private companies
➢ Primary differences between public and private companies
◼ Exchange listing and share ownership transfer
◼ Share issuance
◼ Registration and disclosure requirements
4.2.1.2. Share Issuance
➢ Public: Initial public offering (IPO).
◼ The IPO involves the participation of investment banks who underwrite, or
guarantee, the offering or sale of new (or existing) shares.
◼ Proceeds from the sale of new shares go to the issuing corporation.
◼ Once the IPO process is completed, the company is public and its shares begin
trading on an exchange.
➢ Private: private placement
◼ Investors in private companies are typically invited to purchase shares in the
company through a private placement whose terms are outlined in a legal
document called a private placement memorandum (PPM).
◼ Investors may be restricted to accredited investors, also termed “eligible” or
“professional” investors depending on the jurisdiction
4.2.1.3. Means of Going Private to Public
➢ Initial public offering (IPO).
➢ Direct listing (DL): shares are sold by existing shareholders.
➢ Acquisition.
4.2.1.4. Means of Going Public to Private
➢ LBOs and MBOs are initiated when the investors believe:
◼ the public market is undervaluing the shares
◼ financing costs are sufficiently low and attractive.
➢ Public to Private
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LBO: investors are not affiliated with the company they are buying.
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◼ MBO: investors are the company’s current management team.

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➢ Even though they must pay a premium to convince shareholders to tender (sell) their
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shares, the investors believe the transaction is worth it due to synergies or cost
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savings they believe can be realized by taking the company private.
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4.2.1.
Q-2. A public company can become a private company through a: NOTES module quizes
A. direct listing.
B. leveraged buyout.
C. special purpose acquisition company.
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4.3. Lenders and Owners
4.3.1.
➢ Investor Perspective
Investor Equity Debt
Return potential Unlimited Capped
Maximum loss Initial investment Initial investment
Investment risk higher Lower
Investment interest Max (net asset– liabilities) Timely repayment
◼ Bondholders prefer management to invest in less risky projects.

◼ Equityholders prefer that the company invest in projects that might be riskier
but that have the potential to produce much larger returns.
➢ Issuer Perspective
Issuer Equity Debt
Capital cost Higher Lower
Creates dilution, may be only option

Preferred when issuer cash
attractiveness when issuer cash flows are absent or
flows are predictable
unpredictable
Investment
Lower, holders cannot force liquidation Higher, adds leverage risk
risk
Investment
Max (net asset– liabilities) Debt repayment
interest
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4.3.2.
Q-3. For a company that is financially sound, increasing the company’s rate of growth is most
likely to benefit:
A. equity holders, but not debt holders.
B. both debt holders and equity holders.
C. neither debt holders nor equity holders.
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4.4. Corporate Governance& ESG
4.4.1.
4.4.1.1. Corporate governance

➢ Corporate governance is the internal system including checking, balancing and
incenting various parties, which could minimized and manage the conflicting
interests between insiders and shareholders.
◼ Shareholder theory takes the view that the most important responsibility of a
company’s managers is to maximize shareholder returns.
◼ Stakeholder theory broadens a company’s focus beyond the interests of only
its shareholders to its customers, suppliers, employees, and others who have
an interest in the company.
4.4.1.2. Various stakeholder groups
➢ Shareholders
➢ Managers and employees
➢ Board of directors
➢ Creditors
➢ Suppliers
➢ Customers
➢ Governments/regulators
4.4.1.3. Conflict of interest
➢ Shareholder and creditor
◼ Shareholders would likely prefer riskier projects with a strong likelihood of
higher return potential
◼ Creditors would likely prefer stable performance and lower-risk activities;
➢ Customers and shareholders
◼ A company decides to charge a high price for its products or reduces product
safety features to reduce costs;
➢ Customers and suppliers
◼ A company offers overly lenient credit terms to its customers, whereby the
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company’s ability to repay suppliers on time may be affected;

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➢ Shareholders and governments or regulators

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◼ Bank’s shareholders preferring a lower equity capital base while regulators

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prefer a higher capital position.

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4.4.1.4. Corporate governance and stakeholder management framework
➢ Legal infrastructure defines rights established by law ;
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➢ The contractual infrastructure is shaped by the contractual arrangements entered;
➢ The organizational infrastructure refers to internal systems, governance
procedures, and practices adopted and controlled by the company in managing its
stakeholder relationships;
➢ The governmental infrastructure refers to regulations imposed on companies
4.4.1.5. General meetings

➢ Annual general meeting: companies are ordinarily required to hold an AGM within
a certain period following the end of their fiscal year;
➢ Extraordinary general meetings can be called by the company or by shareholders
throughout the year when significant resolutions requiring shareholder approval are
proposed;
➢ Proxy voting is a process that enables shareholders who are unable to attend a
meeting to authorize another individual to vote on their behalf;
➢ Cumulative voting enables each shareholders to accumulate and vote all his or her
shares for a single candidate in an election involving more than one director.
4.4.1.6. Structure of the board
◼ One tier: comprise a mix of executive and non-executive directors;
◼ Two tier: the supervisory and management boards are independent from each
other (Ex: Separation of CEO and chairman).
4.4.1.7. Committees
➢ Audit committee
◼ Committee member independence;
◼ Committee member qualification;
◼ Independent auditor (internal & external).
➢ Remuneration /compensation committee
◼ Appropriate executive compensation packages;
◼ Reasonable option schemes.
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➢ Nominations committee
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◼ Creating nomination procedures and policies;

◼
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Recruiting qualified board members;

◼ Regularly reviewing performance, independence skills, and experience of
existing board members.
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➢ Governance committee
◼ Develop and oversee the implementation of the corporate governance code,
the charters of the board and its committees, and the company’s code of ethics
and conflict of interest policy;
◼ Reviews regularly, monitoring the implementation;
◼ Recommends remedial actions.
➢ Risk committee
◼ Determines the risk policy, profile, and appetite of the company;
◼ Establishes ERM and monitors their implementation;
◼ Supervises the risk management functions in the company, receives regular
reports, and reports on its findings and recommendations to the board.
➢ Investment committee
◼ Reviews material investment opportunities proposed by management and
considers their viability for the company;
◼ Establishing and revising the investment strategy and policies of the company.
4.4.1.8. Factors affecting stakeholder relationships
➢ Market factors
◼ Shareholder engagement
◼ Shareholder activism
◼ Competitive dynamics
➢ Non-market factors
◼ Legal environment
◼ The media
◼ The corporate governance industry
4.4.1.9. Benefit and risks
➢ Risks of poor governance and stakeholder management
◼ Weak control systems
◼ Ineffective decision making
◼ Legal, regulatory, and reputational
◼ Default and bankruptcy risks
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➢ Benefits of effective governance and stakeholder management

◼ Operational efficiency
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◼ Improved control
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◼ Better operating and financial performance

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◼ Lower default risk and cost of debt

➢ Analyst considerations in corporate governance and stakeholder management:
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◼ Economic ownership and voting control
◆ Dual-class structures: voting power is decoupled from ownership
common shares may be divided into two classes, one of which has
superior voting rights to the other.
◆ Proponents and critics about dual-class structures argue that the systems
promote company stability and enable management to make long-term
strategic investments, insulated from the short-term pressures of outside
investors.
◼ Board of directors representation
◼ Remuneration and company performance
◼ Investors in the company
◼ Strength of shareholders’ rights
◼ Managing long-term risks
4.4.1.10. ESG considerations for investors
➢ Definition: the practice of considering environmental, social, and governance
factors in the investment process is known as ESG integration.
➢ ESG integration
◼ Sustainable investing (SI) and responsible investing(RI): refer to the practice
of considering ESG factors in the investment process;
◼ Socially responsible investing (SRI): represent the practice of excluding
companies and industries that are in opposition to an investor’s moral or
ethical values, such as weapons or tobacco;
➢ ESG implementation methods
◼ Negative screening: refers to the practice of excluding certain sectors.
◼ Positive screening: aims to identify companies that embrace solid ESG-related
principles in their operations and strategies.
◼ The best-in-class approach: seeks to identify the best ESG-scoring companies
in each industry.
◼ Thematic investing strategies: typically consider a single factor, such as energy
efficiency or climate change.
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◼ Full integration: refers to the inclusion of ESG factors or ESG scores in

traditional fundamental analysis.
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◼ Engagement/active ownership investing: refers to using ownership of

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company shares or other securities as a platform to promote improved ESG

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practices.
◼ Green finance: refers to producing economic growth in a more sustainable way
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by reducing emissions and better managing natural resource use. An important
part of green finance is the issuance of green bonds.
◼ Overlay/portfolio tilt strategies: used by fund and portfolio managers to
manage the ESG characteristics of their overall portfolios.
◼ Risk factor/risk premium investing: refers to the treatment of ESG factors as
an additional source of systemic factor risk, along with such traditional risk
factors as firm size and momentum.
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4.4.2.
Q-4. Which of the following scenarios can best be described as offering superior protection
of shareholder interests? (mock 2111)
A. When common law is practiced
B. When CEO duality is common
C. When stakeholder theory prevails
Q-5. Which of the following statements regarding ESG implementation methods is most
accurate? （2020 原版书课后题）
A. Negative screening is the most commonly applied method.
B. Thematic investing considers multiple factors.
C. Relative/best-in-class screening excludes industries with unfavorable ESG aspects.
Q-6. Based on best practices in corporate governance procedures, it is most appropriate for a
company’s compensation committee to: (2020 mock A afternoon)
A. link compensation with long-term objectives.
B. include a retired executive from the firm.
C. include a representative from the firm’s external auditor.
Q-7. Which of the following represents a principal-agent conflict between shareholders and
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A. Risk tolerance
B. Multiple share classes
C. Accounting and reporting practices
Q-8. For shareholders with a small number of shares, which of the type of voting in board
elections they are least likely to choose? 1906
A. statutory voting.
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B. voting by proxy.
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C. cumulative voting.
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Q-9. A credit rating agency assesses a company’s corporate governance structure as favorable
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to creditor rights. The most likely impact of this assessment on the company is a(n):
A. increase in its risk of default.（协会模拟考试题）
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B. reduction in its financial performance.
C. reduction in its cost of debt.
Q-10. Which stakeholders would most likely realize the greatest benefit from a significant
increase in the market value of the company? p644 example
A. Creditors.
B. Customers.
C. Shareholders.
Q-11. A construction company has the opportunity to invest in a high-risk but high-reward
capital infrastructure project. Which of the following could be a reason why the company
decides not to pursue the project? example
A. The compensation of managers is closely tied to the size of the company’s business.
B. The directors receive excessive all-cash compensation.
C. The managers have recently been awarded a generous amount of options to purchase shares
in the company.
Q-12. Which of the following best describes dual-class share structures? example
A. Dual-class share structures can be easily changed over time.

B. Company insiders can maintain significant power over the organization.
C. Conflicts of interest between management and stakeholder groups are less likely than with
single-share structures.
Q-13. A controlling shareholder of XYZ Company owns 55% of XYZ’s shares, and the remaining
shares are spread among a large group of shareholders. In this situation, conflicts of
interest are most likely to arise between: example
A. shareholders and bondholders.

B. the controlling shareholder and managers.
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C. the controlling shareholder and minority shareholders.

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4.5. Business Models
4.5.1.
4.5.1.1. Key features of business model

➢ Value Proposition
◼ Customers, Market: Who (Target customers).
◼ Firm Offering: What (Product/service offering).
◼ Channels: Where (Channel strategy).
◼ Pricing: How Much(Pricing strategy).
➢ Value Chain
◼ Business activities (assets, organization).
◼ Value add and costs per activity.
◼ Competitive advantage.
➢ Profitability
◼ Margins.
◼ Break-even points.
◼ Unit economics: expressing revenues and costs on a per-unit basis
4.5.1.2. Business Model Innovation
➢ Location matters less.
➢ Outsourcing is easier.
➢ Digital marketing makes it easy and cost-effective to reach very specific groups of
customers.
➢ Network effects: increase in value of a network to its users as more users join.
4.5.1.3. Business model variation
➢ Private label or “contract” manufacturers that produce goods to be marketed by
others. This is an extremely common arrangement, particularly for offshore
production.
➢ Licensing arrangements in which a company will produce a product using someone
else’s brand name in return for a royalty.
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➢ Value added resellers that not only distribute a product but also handle more
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complex aspects of product installation, customization, service, or support.

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➢ Franchise models in which distributers or retailers have a tightly defined and often
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exclusive relationship with the parent (franchisor) company.

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➢ E-commerce Business Models

◼ Affiliate marketing generates commission revenues for sales generated on
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others’ websites.
◼ Marketplace businesses create networks of buyers and sellers without taking
ownership of the goods during the process.
◼ Aggregators are similar to marketplaces, but the aggregator re-markets
products and services under its own brand.
◼ Crowdsourcing to contribute directly to a product, service, or online
content.
➢ Hybrid Business Models: combining platform and traditional “linear” businesses.
4.5.1.4. External Factors
➢ Economic conditions affect almost all businesses.
➢ Demographic trends influence the overall economy, but in certain markets, they are
important in their own right.
➢ Sector demand characteristics vary by industry. Some industries, such as consumer
staples, have very stable and predictable demand, while others, such as industrial
machinery, are more cyclical.
➢ Industry cost characteristics, such as capital intensity and operating leverage, are
also important.
➢ The political, legal, and regulatory environment is also a key “external” factor for
many businesses.
➢ Social and political trends: Shifts in public opinion and tastes often precede changes
in consumer buying behavior or the political/legal environment.
4.5.1.5. Firm-Specific Factors
➢ Firm maturity or stage of development of the business: A startup or early-stage
business typically requires more capital, such as that needed to finance new facilities
or for “investment spending” on product development, marketing/sales, working
capital, and/or startup losses, and presents more business risk than a more mature
business.
➢ Competitive position: A company with strong barriers to competition, also referred
to as a “wide moat,” will have lower business and financial risk than one that does
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➢ Business model
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◼ Asset-light business models shift the ownership of high-cost assets to other

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◼ Lean startups extend this logic to human resources, outsourcing as many

functions as possible. Technology companies frequently adopt this approach,
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to accelerate their development and to increase their agility.
◼ Pay-in-advance business models reduce or eliminate the need for working
capital.
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4.5.2.
Q-14. A business model is least likely to include details about a company’s: example
A. largest customers.
B. workforce characteristics.
C. revenue and expense estimates.
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4.6. Business Risks
4.6.1.
4.6.1.1. Macro Risks

➢ Risk that management, debtholders, and equity investors consider arises from the
economic environment in which a business operates (macro risk), the business
itself (business risk), and the way the business is financed (financial risk).
➢ Macro risk refers to the risk from political, economic, legal, and other institutional
risk factors that impact all businesses in an economy, a country, or a region.
4.6.1.2. Business risks
➢ Business risk is the risk that the firm’s operating results will be different from
expectations, independently of how the business is financed.
➢ Business risk includes both industry risk and company-specific risk.
4.6.1.3. Industry risks
➢ Cyclicality is a feature of many industries, particularly discretionary goods.
➢ Industry structure has an impact on the overall risk of the industry.
◼ Lower concentration (i.e., the presence of many small competitors
HHI) is generally associated with a high degree of competitive intensity.

➢ Competitive intensity influences overall industry profitability.
➢ Competitive dynamics within the value chain (Porter’s Five).
➢ Long-term growth and demand outlook
➢ Other industry risks include regulatory and other potential external risks to industry
demand and profitability.
4.6.1.4. Company-Specific Risks
➢ Competitive risk can be defined as the risk of a loss of market share or pricing power
to competitors and often reflects a lack of competitive advantage.
◼ Cost advantages;
◼ Product or service differentiation;
◼ Network effects;
◼ Switching barriers are factors that make it more difficult or more costly to
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switch suppliers.
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➢ Product market risk is the risk that the market for a new product or service will fall
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short of expectations.
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Execution risk arises from the possibility that management will be unable to do what
is needed to deliver the expected results.
◼ Capital investment risk is the potential for sub-optimal investment by a firm.
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◼ ESG risk
➢ Operating leverage.
4.6.1.5. Financial Risks
➢ Financial risk refers to the risk arising from a company’s capital structure and,
specifically, from the level of debt and debt-like obligations (such as leases and
pension obligations) involving fixed contractual payments.
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4.6.2.
Q-15. Which of the following is most likely referred to as a firm-specific risk? A firm’s:
A. competitive position. example
B. exchange rate uncertainty.

C. exposure to demographic trends.
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4.7. Classification of Capital Project
4.7.1.
4.7.1.1. capital projects
➢ Replacement projects
◼ To maintain the current business: equipment breaks down or wears out;
◼ For cost reduction purpose: purchase more efficient equipment instead of
the old one.
➢ Extension projects
◼ Expansion projects for existing product: increase the size of business;
◼ Expansion projects for new product or new services;
◼ The order of uncertainty: replacement project< expansion project < new
products.
➢ Mandatory investment: regulatory, safety, and environmental project (
NPV<0).
➢ Other projects: such as CEO buying a new aircraft.
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4.7.2.
Q-16. A large corporation accepts a project which generates no revenue and has a negative net
present value. The project is most likely classified in which of the following categories?
A. Replacement project.
B. New product or service.

C. Regulatory or environmental project.
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4.8. Key Principals of Capital Budgeting
4.8.1.
4.8.1.1. The capital budgeting process involves five key principles

➢ Decisions are based on the incremental cash flows.
◼ Incremental cash flow
◆ cash flow decision
◆ opportunity costs
externality ( negative externality: cannibalization);
sunk cost finance cost (interest costs).
◼ Decisions are based on cash flows, instead of accounting net income;

➢ Timing of cash flows are crucial time value of money
➢ Cash flows are analyzed on an after-tax basis
➢ Cash flows that should be ignored in capital budgeting
◼ suck cost: the costs have already been incurred, which would not be
affected by the decision of adopting the project
◼ financing costs/interest cost: the costs have already been reflected
in the required rate of return

➢ Cash flows that should be included in capital budgeting
◼ Externality: the effect of an investment on other things besides the
investment itself
◆ Negative externality (cannibalization): the new project may take sales
away from current projects;
◆ Positive externality: the new project may benefit current projects.
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opportunity cost: The cash flow that a firm will lose by the next best
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4.8.2.
Q-17. Which of the following statements describes the most appropriate treatment of cash
flows in capital budgeting?(2111 mock)
A. Interest costs are included in the project’s cash flows to reflect financing costs.
B. A project is evaluated using its incremental cash flows on an after-tax basis.
C. Sunk costs and externalities should not be included in the cash flow estimates.
Q-18. An analyst is estimating the NPV of a project to introduce a new spicier version of its
well-known barbeque sauce into its product line. A cost that should most likely be
excluded from his analysis is:
A. $200,000 to develop a recipe for the new sauce.
B. a $150,000 decrease in sales of its current sauce as some current customers switch to the
spicier sauce.
C. $100,000 for a marketing survey that was conducted to determine demand for a spicier sauce.
Q-19. The acceptance of which of the following capital budgeting projects is most likely to
expose a company to the highest level of uncertainty? (2020 mock A morning)

A. Replacement of worn out equipment
B. Expansion projects
C. Newly launched product or services
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4.9. Project Evaluation Methods NPV, IRR, ROIC
4.9.1.
4.9.1.1. Evaluation of a capital project
➢ Independent projects
◼ Accepting or rejecting one project does not affect the decision of other
projects.
➢ Mutually exclusive
◼ Projects compete directly with each other. Mutually exclusive projects are
not independent projects.
➢ Project sequencing
◼ Projects are sequenced through time, so that investing in a project creates
the option to invest in future projects.
➢ Unlimited funds
◼ Company can raise the funds it wants for all profitable projects by paying the
required rate of return.
➢ Capital rationing
◼ Company has a limited amount of funds to invest
4.9.1.2. The calculation of NPV, IRR,ROIC
➢ NPV
𝐶𝐹𝑡
◼ NPV = ∑𝑛𝑡=0
(1+𝑟)𝑡
◼ Decision rule: NPV 0 NPV
➢ IRR
◼ NPV 0
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◼ Decision rule: IRR

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IRR
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◼ NPV IRR NPV
➢ Return on invested capital (ROIC)

◼ Return on invested capital=(after tax net profit)/(book value of invested
capital)
◆ Invested capital includes: Common shares ; Preferred shares ; Debt
◼ Decision rule
◆ If ROIC COC, company generates a higher return for investors,
increasing the firm’s value for shareholders.
◆ If ROIC COC, the company generates a lower return for investors,
decreasing the firm’s value for shareholders.

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4.9.2.
Q-20. A firm is considering a project that would require an initial investment of THB270 million
(Thai baht). The project will help increase the firm’s after-tax net cash flows by THB30
million per year in perpetuity, and it is found to have a negative NPV of THB20 million.
The IRR (%) of the project is closest to: (2020 mock B morning)
A. 11.1%.
B. 10.3%.
C. 12.0%.
Q-21. A company has a fixed $1,100 capital budget and has the opportunity to invest in the
four independent projects listed in the table: 18
Project Investment outlay NPV

1 $600 $100
2 $500 $100
3 $300 $50
4 $200 $50
The combination of projects that provides the best choice is:
A. 2, 3, and 4.
B. 1, 3, and 4.
C. 1 and 2.
Q-22. Two mutually exclusive projects have the following cash flows (€) and internal rates of
return (IRR):
Project IRR Year 0 Year 1 Year 2 Year 3 Year 4
A 27.97% -4,900 690 1,698 1,270 7,290
B 28.37% -4,900 690 1,698 2,102 6,350
Assuming a discount rate of 8% annually for both projects, the firm should most likely
accept:
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A. both projects.
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B. Project A only.
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C. Project B only.
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Q-23. The Bearing Corp. invests only in positive-NPV projects. Which of the following
statements is true?( )
A. Bearing’s return on invested capital (ROIC) is greater than its cost of capital (COC).
B. Bearing’s COC is greater than its ROIC.
C. We can’t reach any conclusions about the relationship between the company’s ROIC and COC.
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4.10. NPV& IRR
4.10.1.
4.10.1.1. NPV, IRR comparison
➢ Advantages of NPV & IRR
◼ Based on cash flows;

◼ Considering time value of money——opportunity cost;
◼ Take into account the cash flows generated over the whole project life.
➢ NPV advantage
◼ Shows the amount of gains as currency amount;
◼ The NPV of project increases the value of shareholders instead of creditors;
◼ Realistic discount rate – opportunity cost of funds.
➢ NPV disadvantage
◼ Size effect ignored.
➢ IRR advantage
◼ Reflect the profitability of the project.
➢ IRR disadvantage
◼ Assume the reinvestment rate is IRR;
◼ No IRR & multiple IRR (unconventional CFs);
◼ Conflicting ranking results of mutually exclusive projects with NPV.
4.2.1.1. NPV profile:
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IRR crossover rate,

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➢ NPV profile NPV=0 IRR
➢ NPV profile 0 NPV
➢ Crossover rate: NPV profile
NPV
4.2.1.2. NPV IRR IRR
◼ Different project’s size;

◼ Different timing of CF;
◼ Reinvestment rate assumption different.
➢ IRR NPV NPV.
4.2.1.3. Criteria preference

➢ European countries prefer PB over NPV and IRR
➢ Larger public companies prefer NPV&IRR
➢ Managers with higher education level prefer NPV&IRR.
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4.10.2.
Q-24. Given two mutually exclusive projects with normal cash flows, the point at which their
net present value profiles intersect the horizontal axis is most likely the projects’:
A. weighted average cost of capital.
B. crossover rate.
C. internal rate of return.
Q-25. Wilson Flannery is concerned that this project has multiple IRRs.
Year 0 1 2 3
Cash flows —50 100 0 —50
How many discount rates produce a zero NPV for this project?
A. One, a discount rate of 0 percent.

B. Two, discount rates of 0 percent and 32 percent.
C. Two, discount rates of 0 percent and 62 percent.
Q-26. Two mutually exclusive projects have conventional cash flows, but one project has a
larger NPV while the other has a higher IRR. Which of the following is least likely
responsible for this conflict?
A. Reinvestment rate assumption.

B. Size of the projects' initial investments.
C. Risk of the projects as reflected in the required rate of return.
Q-27. Erin Chou is reviewing a profitable investment project that has a conventional cash flow
pattern. If the cash flows for the project, initial outlay, and future after-tax cash flows all
double, Chou would predict that the IRR would:
A. increase and the NPV would increase.

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C. stay the same and the NPV would stay the same.
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4.11. Impact of NPV Rule and Stock Price
4.11.1.
4.11.1.1. Impact of NPV rule and stock price

➢ The relationship for NPV of the project and firm’s value
◼ NPV is positive
◆ Firm value is increased;
◆ Shareholder wealth is increased.
◼ NPV is zero
◆ Shareholder wealth remain constant.
◼ NPV is negative
◆ Shareholder wealth is decreased.
➢ The relationship between NPV rule and the stock price
◼ In theory
◆ When the NPV is positive, Pstock is increased, vice versa;
◆ ∆price per share=NPV/ outstanding common shares.
◼ In reality
◆
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4.11.2.
Q-28. A company has 100 million shares outstanding. The share price of a company’s stock is
£15 just prior to announcing a £100 million expansionary investment in a new plant, and
the company estimates that the present value of future after-tax cash flows will be £150
million. Analysts, however, estimate that the new plant’s profitability will be lower than
the company’s expectations. The company’s stock price will most likely:
A. drop below £15 per share due to the cannibalization of revenue from the new plant.
B. increase by less than £0.50 per share.
C. increase by the new plant’s net present value per share.
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4.12. Real Options
4.12.1.
4.12.1.1. Real Options

➢ Timing Options
➢ Sizing options
◼ Abandonment option
◼ Growth (expansion) option
➢ Flexibility options: once an investment is made, other operational flexibilities
may be available besides abandonment or expansion.
◼ Price-setting options
◼ Production flexibility options
➢ Fundamental options
➢ Four common sense approaches to real options analysis
◼ Project NPV(with option) = NPV(without option) - Cost of options + Value of
options
◼ Use DCF analysis without considering options
◼ Use decision trees
◼ Use option pricing models
4.12.1.2. Common capital budgeting pitfalls
➢ Not incorporating economic responses into the investment analysis
➢ Misusing capital allocation template
➢ Pushing pet projects
➢ Basing investment decisions on EPS, net income, or ROE
➢ Using IRR to make investment decisions
➢ Incorrectly accounting for cash flows
➢ Over- or underestimating overhead costs
➢ Not using the appropriate risk-adjusted discount rate
➢ Overspending and underspending the capital allocation
➢ Failing to consider investment alternatives or alternative states
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4.12.2.
Q-29. Albert Duffy, a project manager at Crane Plastics, is considering taking on a new capital
project. When presenting the project, Duffy shows members of Crane's executive
management team that because the company has the ability to have employees work
overtime, the project makes sense. The project Duffy is taking on would be best
described as having:
A. a fundamental option.
B. an expansion option.
C. a flexibility option.
Q-30. A company is considering building a distribution center that will allow it to expand sales
into a new region comprising three provinces. John Parker, a firm analyst, has argued
that the current analysis fails to incorporate the amount they could get from selling the
distribution center at the end of year 2, rather than operating it to the end of the
project's assumed economic life. Parker is suggesting that:
A. the assumed investment horizon is too long.
B. the analysis should include the value of a put option.
C. the analysis should include the value of a call option.
Q-31. AquaFarms has estimated the NPV of the expected cash flows from a new processing
plant to be –EUR0.40 million. Auvergne is evaluating an incremental investment of
EUR0.30 million that would give the company the flexibility to switch among coal, natural
gas, and oil as energy sources. The original plant relied only on coal. The option to switch
to cheaper sources of energy when they are available has an estimated value of EUR1.20
million. What is the value of the new processing plant including this real option to use
alternative energy sources? example
A. EUR0.80 million
B. EUR0.50 million
C. EUR0.90 million
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4.13. Corporate Financing Sources
4.13.1.
4.13.1.1. Internal funding sources

➢ After-tax operating cash flows
➢ Accounts payable
➢ Accounts receivable
➢ Inventory & marketable securities
4.13.1.2. External funding sources
➢ Financial intermediaries
◼ Uncommitted lines of credit
◼ Committed lines of credit
◼ Revolving credit
◼ Secured loans
◼ Factoring
➢ Capital markets
◼ Commercial paper
◼ Public & private debt
◼ Hybrid securities
◼ Common equity
➢ Other
◼ Leasing
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4.13.2.
Q-32. A company has an agreement with its lender to borrow funds as they need to up to a
specified maximum amount and to repay its borrowings as they have funds available
periodically. This arrangement is most appropriately called: (notes)
A. a committed line of credit.
B. a revolving line of credit.
C. a capped line of credit.
Q-33. Two analysts are discussing the costs of external financing sources. The first states that
the company’s bonds have a known interest rate but that the interest rate on accounts
payable and the interest rate on equity financing are not specified. They are implicitly
zero. Upon hearing this, the second analyst advocates financing the firm with greater
amounts of accounts payable and common shareholders equity. Is the second analyst
correct in his analysis?
A. He is correct in his analysis of accounts payable only.

B. He is correct in his analysis of common equity financing only.
C. He is not correct in his analysis of either accounts payable or equity financing.
Q-34. GF Company needs to raise 75 million, in local currency, for substantial new investments
next year. Specific details, all in local currency, are as follows:
⚫ Investments of 10 million in receivables and 15 million in inventory. Fixed capital
investments of 50 million, including 10 million to replace depreciated equipment
and 40 million of net new investments. Net income is expected to be 30 million, and
dividend payments will be 12 million. Depreciation charges will be 10 million.
⚫ Short-term financing from accounts payable of 6 million is expected. The firm will
use receivables as collateral for an 8 million loan. The firm will also issue a 14 million
short-term note to a commercial bank. Any additional external financing needed
can be raised from an increase in long-term bonds. If additional financing is not
needed, any excess funds will be used to repurchase common shares.
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What additional financing does GF require?

A. GF will need to issue 19 million of bonds.
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B. GF will need to issue 26 million of bonds.

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C. GF can repurchase 2 million of common shares.

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4.14. Working Capital Approach
4.14.1.
➢ Companies take different approaches to working capital management

◼ Conservative:
◆ The firm holds a larger position in cash, receivables, and inventories,
relative to sales.
◆ Finances its current assets with long-term debt or equity financing.
◼ Aggressive:
◆ In an aggressive approach the firm has substantially less committed to
current assets.
◆ Finances the majority of its current assets with short-term debt or
payables.
◼ Moderate:
◆ The firm holds a position somewhere between the two approaches.
◆ Using short and long-term financing methods, focusing on a liability-
matching approach.
➢ One way to evaluate the financial impact of a firm’s working capital approach is
to use the DuPont equation
net income
◼ Return 𝑜𝑛 equity (ROE) =
average shareholde′ s equity
net income salses average total assets

◼ ROE = ( 𝑠𝑎𝑙𝑒𝑠
)(average total assets) (average shareholde′ s equity)
◼ ROE =(Net profit margin) × (Total asset turnover) × (Leverage)

◼ To assess the impact on returns, should focus on the total asset turnover
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4.14.2.
Q-35. Which of the following most likely represents conservative working capital management?
A. Decreasing inventory on hand to reduce insurance costs.
B. Financing an increase in receivables by increasing long-term borrowing.
C. Selling marketable securities and using the proceeds to acquire real estate.
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4.15. Liquidity Measures and Management
4.15.1.
4.15.1.1.
➢ Primary sources of liquidity represent the most readily accessible resources

available.
◼ Ready cash balances: cash available at bank accounts resulting from payment
collections, investment income, liquidation of near-cash securities;
◼ Short-term funds;
◼ Cash flow management.
➢ Secondary sources of liquidity may result in a change in the company’s financial
and operating positions.
◼ Negotiating debt contracts;
◼ Liquidating long-term/ short-term assets with no substantial loss in value;
◼ Filing for bankruptcy protection and reorganization.
➢ Primary sources secondary sources
4.15.1.2. Liquidity measures

➢ Working capital management is a concern regarding firm liquidity
◼ Drags on liquidity: when receipts lag, creating pressure from the decreased
available funds;
◼ Pulls on liquidity: disbursements are paid too quickly or trade credit
availability is limited, requiring companies to expand fund before the sales
fund comes to cover the liability.
➢ Liquidity ratios:
current assets
◼ current ratio=
current liabilities
:
cash+short-term marketable securities+receivables

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quick ratio=
current liabilities
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cash+short-term marketable securities

◼ cash ratio=
current liabilities
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◼ The higher the liquidity ratio, the more likely it is the company will be able
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to pay its short-time bills.

➢ Receivable turnover: a measure of accounts receivable liquidity.
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credit sales
◼ Receivables turnover=
receivables
365
◼ Number of days receivable=
receivable turnover
➢ Inventory turnover: a measure of a firm’s efficiency with respect to its processing
and inventory management.
◼ cost of goods sold purchases

Inventory turnover= =
inventory inventory
◼ 365
Number of days inventory=
inventory turnover
➢ Payables turnover: a measure of the use of credit by the firm.
◼ purchases
Payables turnover ratio=
trade payables
◼ 365
Number of days of payables=
payables turnover ratio
➢ Operating cycle: the average number of days that it takes to turn raw materials
into cash proceeds forms.
◼ Operating cycle=days of inventory+days of receivables
Cash conversion cycle (net operating cycle)
◼
=days of inventory+days of receivables-days of payable
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4.15.2.
Q-36. The following information is available for a company and the industry in which it
competes:
Company Industry
Accounts receivable turnover 5.6 times 6.5 times
Inventory turnover 4.2 times 4.0 times
Number of days of payables 28 days 36 days
Operating cycle ? 147 days
Cash conversion cycle 124 days ?
Relative to the industry, the company’s operating cycle:
A. is shorter, but its cash conversion cycle is longer.
B. and cash conversion cycle are both longer.
C. is longer, but its cash conversion cycle is shorter.
Q-37. Which is most likely considered a “pull” on liquidity? (2020 mock B afternoon)
A. Increased difficulty in collecting receivables.
B. Obsolete inventory.
C. Reduction in a line of credit.
Q-38. Quixote Co. and Sisyphus Co., two similar-sized competitors, have had stable operating
cycles of 180 days and cash conversion cycles of 140 days over the past several years.
Sisyphus' operating and cash conversion cycles remained at these levels in the most
recent year, but Quixote's cash conversion cycle contracted to 120 days while its
operating cycle remained at 180 days. Relative to Sisyphus, Quixote has most likely begun:
A. taking more time to pay its suppliers.
B. operating with less inventory on hand.
C. offering easier credit terms to its customers.
Q-39. Which action is most likely considered a secondary source of liquidity? (2020 mock A mo
A. Increasing the efficiency of cash flow management
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Q-40. Keown Corp. is considering increasing the line of credit it offers to new customers
because its sales manager believes this will lead to increased sales. What would be the
expected impact on Keown’s working capital if this change were made?
A. The company would reduce its inventory levels.
B. The company would likely collect faster, reducing its receivables.
C. The company would have an increased need for working capital.
Q-41. Which of these does not contribute to the firm’s liquidity issue?
A. The change in days in receivables
B. The change in inventory turnover
C. The change in credit limits
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4.16. WACC
4.16.1.
4.16.1.1. WACC
WACC= ( wd ) rd (1-t )  + ( wps )(rps ) + ( wce )(rs )

➢ Where:
◼ t is the firm's marginal tax rate;
◼ w is the proportion of each type of capital, all the components are using
market value when computing weightings;
◼ r is the current cost of each type of capital.
➢ The priority sequencing of choosing capital structure
◼ The company’s target capital structure;

◼ The company’s current capital structure;
◼ The trends in capital structure;
◼ The average of comparable company’s capital structure.
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4.16.2.
Q-42. An analyst gathered the following Information about the capital structure and before-tax
component costs for a company. The company’s marginal tax rate is 40%.
Capital component Book Value (000) Market Value(000) Component cost
Debt $100 $80 8%
Preferred stock $20 $20 10%

Common stock $100 $200 12%
The company’s weighted average cost of capital (WACC) is closest to: 1906
A. 8.55%.
B. 9.95%.
C. 10.00%.
Q-43. A firm with a marginal tax rate of 40% has a weighted average cost of capital of 7.11%.
The before-tax cost of debt is 6%, and the cost of equity is 9%. The weight of equity in
the firm’s capital structure is closest to:
A. 79%.
B. 65%.
C. 37%.
Q-44. Which of the following is the least appropriate method for an external analyst to
estimate a company’s target capital structure for determining WACC? Using the:
A. averages of comparable companies’ capital structure.
B. company’s current capital structure, at book value weights.

C. statements made by the company’s management regarding capital structure policy.
Q-45. When estimating the NPV for a project with a risk level higher than the company’s
average risk level, an analyst will most likely discount the project’s cash flows by a rate
that is:
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A. determined by the firm’s target capital structure.

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B. below the WACC.

C. above the WACC.
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4.17. Cost of Debt
4.17.1.
4.17.1.1. Cost of debt
➢ Yield to maturity approach
◼ bond yield.
◆ yield
◆ PV FV PMT
cost of debt
➢ Debt rating approach
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4.17.2.
Q-46. The cost of debt can be determined using the yield-to-maturity and the bond rating
approaches. If the bond rating approach is used, the:

A. coupon is the yield.
B. yield is based on the interest coverage ratio.
C. company is rated and the rating can be used to assess the credit default spread of the
company’s debt.
Q-47. A company issues new 20-year $1,000 bonds with a coupon rate of 6.2% payable
semiannually at an issue price of $1,030.34. Assuming a tax rate of 28%, the firm’s annual
after-tax cost of debt (%) is closest to: 18
A. 5.94.
B. 4.28.
C. 4.46.
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4.18. Cost of Equity
4.18.1.
4.18.1.1. Cost of equity
➢ CAPM
◼ 𝒓𝒆 = 𝒓𝒇 + 𝜷(𝒓𝒎 − 𝒓𝒇 )
◼ market portfolio return market risk
premium
➢ DDM
◼ dividend current (D0) expected
(D1) re = D1/ P0 + g D0 D0(1+g)
D1.
◼ stable dividend policy
without issuing additional common stock g=(1-DPS/EPS)ROE.
◼ D1/ P0 forward annual dividend yield.
➢ Bond yield plus risk premium
◼ Bond yield plus risk premium: premium cost of equity
cost of debt
4.18.1.2. cost of preferred stock:
➢ D/P;
➢ preferred stock tax advantage.

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4.18.2.
Q-48. An analyst gathered the following information about a company and the market:
Current market price per share of common stock 25.00
Most recent dividend per share paid on common stock (D0) $1.50
Expected dividend payout rate 50%
Expected return on equity (ROE) 20%
Beta for the common stock 1.2
Expected rate of return on the market portfolio 15%
Risk-free rate of return 5%
Using the discounted cash flow (DCF) approach and CAPM, the cost of retained earnings
for the company is closest to:
A. 15.7% and 16.6%, respectively.

B. 16.6% and 17%, respectively.
C. 17.0% and 15.7%, respectively.
Q-49. A fund manager gathers the following data to assess a stock’s potential for a possible
addition to her portfolio:
Company’s net income $20 million

Company’s equity at the beginning of the year $140 million
Company’s weighted average cost of capital (WACC) 10.75%
Stock’s beta 1.80
Market risk premium 5.25%
Risk-free rate 3.50%
Fund manager’s required rate of return 13.60%
Which of the following is the most appropriate decision for the fund manager?
A. Do not invest in the stock.
B. Invest in the stock because the required rate of return is greater than the company’s WACC.
C. Invest in the stock because the company’s ROE is greater than the required rate of return.
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Q-50. Which method of calculating the firm’s cost of equity is most likely to incorporate the
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B. Dividend discount model
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C. Bond yield plus risk premium approach
Q-51. A 20-year $1,000 fixed-rate non-callable bond with 8% annual coupons currently sells for
$1,105.94. Assuming a 30% marginal tax rate and an additional risk premium for equity
relative to debt of 5%, the cost of equity using the bond-yield-plus-risk-premium
approach is closest to: (2020 mock B afternoon)
A. 9.9%
B. 12.0%
C. 13.0%
Q-52. The following information is available for a company:

⚫ Bonds are priced at par and have an annual coupon rate of 9%.
⚫ Preferred stock is priced at $8 and pays an annual dividend of $1.20.
⚫ Common equity has a beta of 1.2.
⚫ The risk-free rate is 5% and the market premium is 12%.
⚫ Capital structure: Debt = 40%; Preferred stock = 10%; Common equity = 50%.
⚫ The tax rate is 30%.
The weighted average cost of capital (WACC) for the company is closest to:
A. 13.7%
B. 14.0%
C. 14.8%
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4.19. Estimate Beta and Pure-Play Method
4.19.1.
4.19.1.1. β
➢ For public company

◼ Unadjusted or “ raw” historical beta
◆ Using simple regression
◆ Factors of actual beta value
◼ Adjusted beta
◆ Since beta tends to regress toward mean value of 1.0
◆ Valuation is forward looking, thus accurately predicts a future beta
◆ Adjusted beta = (2/3)(Unadjusted beta) + (1/3)(1.0)
◼ From financial analysis vendors
◆ Bloomberg
➢ Pure-play method (non-public companies)
◼ (X)
(Y) equity β
◼ (Y) assetβ,
debt equity tax rate
βequity
◆ β*asset =
 D
1 + (1 - t ) E 
◼ (Y) assetβ
β debt equity tax

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 D' 
◆ βequity =β*asset 1+ (1-t' ) ' 
 E 
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◆ D/E ratio
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Y Y D/E ratio
X X D/E ratio
◼ CAPM cost of equity
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4.19.2.
Q-53. A company’s asset beta is 1.2 based on a debt-to-equity ratio (D/E) of 50%. If the
company’s tax rate increases, the associated equity beta will most likely:
A. increase.
B. decrease.
C. remain unchanged.
Q-54. An analyst gathered the following information about a private company and its publicly
traded competitor: （2020 原版书）
Comparable Companies Tax Rate (%) Debt/Equity Equity Beta
Private company 30 1 N.A.
Public company 35 0.9 1.75
Using the pure-play method, the estimated equity beta for the private company is
closest to:
A. 1.029.
B. 1.104.
C. 1.877.
Q-55. Brandon Wiene is a financial analyst covering the beverage industry. He is evaluating the
impact of DEF Beverage’s new product line of flavored waters. DEF currently has a debt-
to-equity ratio of 0.6. The new product line would be financed with $50 million of debt
and $100 million of equity. In estimating the valuation impact of this new product line
on DEF's value, Wiene has estimated the equity beta and asset beta of comparable
companies. In calculating the equity beta for the product line, Wiene is intending to use
DEF's existing capital structure when converting the asset beta into a project beta. Which
of the following statements is correct? (2020 )
A. Using DEF’s debt-to-equity ratio of 0.6 is appropriate in calculating the new product line's
equity beta.
B. Using DEF’s debt-to-equity ratio of 0.6 is not appropriate, but rather the debt-to-equity ratio
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Q-56. Wang Securities had a long-term stable debt-to-equity ratio of 0.65. Recent bank
borrowing for expansion into South America raised the ratio to 0.75. The increased
leverage has what effect on the asset beta and equity beta of the company?
A. The asset beta and the equity beta will both rise.
B. The asset beta will remain the same and the equity beta will rise.
C. The asset beta will remain the same and the equity beta will decline.
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4.20. Flotation Cost
4.20.1.
4.20.1.1. flotation cost
➢ 1
◼ Flotation cost
𝐷
◆ 1
𝑟𝑒 = 𝑃 −𝐹 +𝑔 flotation cost
0
𝐷1
◆ 𝑟𝑒 = +𝑔 flotation cost
𝑃0 (1−𝑓)
➢ 2
◼ CFA flotation cost initial cash outflow
𝑪𝑭𝒊
◆ 𝐍𝐏𝐕 = −𝐢𝐧𝐢𝐭𝐢𝐚𝐥 𝐜𝐚𝐬𝐡 𝐨𝐮𝐭𝐟𝐥𝐨𝐰 − 𝐟𝐥𝐨𝐭𝐚𝐭𝐢𝐨𝐧 𝐜𝐨𝐬𝐭 + ∑𝒏𝒊=𝟏
(𝟏+𝐖𝐀𝐂𝐂)𝒊
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4.20.2.
Q-57. Which of the following statements is the most appropriate treatment of flotation costs for
capital budgeting purposes? Flotation costs should be: 18
A. expensed in the current period.

B. incorporated into the estimated cost of capital.
C. deducted as one of the project’s initial-period cash flows.
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4.21. Capital Structure
4.21.1.
4.21.1.1. MM Factors that may affect capital structure

➢ Company life cycle
➢ Cost of capital
➢ Financing considerations
➢ Competing stakeholder interests
4.21.1.2. Capital Structure and Company Life Cycle
Stage in life cycle Start-up Growth Mature
Financial management
Revenue growth Beginning Rising Slowing
Cash flow Negative improving Positive/ predictable
Business risk High Medium Low
Debt capital/leverage
Very
Availability Limited/ improving High
limited
Cost High Medium Low
Secured (by receivables, Unsecured (bank and

Typical cases N/A
fixed assets) public debt)
Typical % of capital Close to

0%~20% 20%+
structure* 0%
*: These ratios are calculated based on the market values of equity and debt
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4.21.2.
Q-58. A company is most likely to be financed only by equity during its:

A. start-up stage.
B. growth stage.
C. mature stage.
Q-59. A company's optimal capital structure:

A. maximizes firm value and minimizes the weighted average cost of capital.
B. minimizes the interest rate on debt and maximizes expected earnings per share.
C. maximizes expected earnings per share and maximizes the price per share of common stock.
Q-60. A growth retail business that is expected to generate positive operating cash flows in the
next 3–5 years would normally be financed with: example
A. little or no debt.
B. significant debt to minimize equity dilution.
C. significant debt to minimize its weighted average cost of capital.
Q-61. Green Company and Black Company are each achieving 15% annual revenue growth and
have recently started to generate positive cash flow. Green Company owns and acquires
renewable energy generation projects. Black Company is a cloud-based software company
with a dominant market position, serving auto dealers. Which company is more likely to
have greater debt in its capital structure, and why? example
A. Black Company, because it serves a cyclical business.

B. Black Company, because of the strength of its market position.
C. Green Company, because its underlying assets can be financed with debt.
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4.22. MM Propositions
4.22.1.
4.22.1.1. MM proposition 1 without taxes

➢ The net present value (NPV) is the present value of all after-tax cash flows.
➢ With the increase in leverage, the increase in equity returns is offset by increases
in the risk and the associated increase in the required rate of return on equity.
➢ Assumptions
◼ Investors agree on the expected cash flow from a given investment;
◼ Bonds and shares of stock are traded in a perfect capital market;
◼ Investors can borrow/lend at the risk-free rate;
◼ No agency costs;
◼ Financing decision and investment decision are independent.
4.22.1.2. MM proposition 2 without taxes
➢ With the increase in leverage, the increase in equity returns is offset by increases
in the risk and the associated increase in the required rate of return on equity.
➢ The cost of equity is a linear function of D/E
➢ 假设：
◼ Financial distress has no cost
◼ Debt holders have prior claim to assets and income
4.22.1.3. MM proposition 1 (with taxes)

➢ Optimal capital structure is 100% debt
VL = VU + t  d
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4.22.1.4. MM proposition 2 (with taxes)

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➢ WACC is minimized at 100% debt.

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➢ We do not consider the costs here:

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◼ Cost of financial distress;

◼ Cost of bankruptcy.
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𝑬𝑩𝑰𝑻(𝟏 − 𝒕)
𝑽𝑳 =
𝑾𝑨𝑪𝑪
4.22.1.5. Summary for MM theory
When t ≠ 0, (1 - t) lowers cost of leveraged equity compared to no-tax case
➢ re becomes greater as the company increases the debt financing, but re does not
rise as fast as it does in the no-tax case. Because the slope coefficient (r0-rd) (1-t)
< (r0-rd) in the case of no taxes.
➢ WACC for the leveraged company falls as debt increases, and overall company
value increases.
➢ If taxes are considered but financial distress and bankruptcy costs are not, debt
financing is highly advantageous. In extreme, optimal capital structure is 100%
debt.
Without taxes With taxes
Proposition 1 VL=VU VL=VU +t*D
Proposition 2 re= r0+(r0-rd)*D/E re= r0+(r0-rd)(1-t)*D/E
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4.22.2.
Q-62. If investors have homogeneous expectations, the market is efficient, and there are no
taxes, no transactions costs, and no bankruptcy costs, the Modigliani and Miller
Proposition I states that:
A. bankruptcy risk rises with more leverage.
B. managers cannot change the value of the company by using more or less debt.
C. managers cannot increase the value of the company by employing tax saving strategies.
Q-63. Which of the following statements regarding Modigliani and Miller's Proposition I is most
accurate?
A. A firm's cost of equity financing increases as the proportion equity in a firm's capital structure
is increased.
B. A firm's cost of debt financing increases a firm's financial leverage Increases.
C. A firm's weighted average cost of capital is not affected by its choice of capital structure.
Q-64. According to Modigliani and Miller’s Proposition II without taxes:

A. the capital structure decision has no effect on the cost of equity.
B. investment and the capital structure decisions are interdependent.
C. the cost of equity increases as the use of debt in the capital structure increases.
Q-65. Suppose the weighted average cost of capital of the Gadget Company is 10 percent. If
Gadget has a capital structure of 50 percent debt and 50 percent equity, a before-tax
cost of debt of 5 percent, and a marginal tax rate of 20 percent, then its cost of equity
capital is closest to:
A. 12 percent.
B. 14 percent.
C. 16 percent.
Q-66. The current weighted average cost of capital (WACC) for Van der Welde is 10 percent.
The company announced a debt offering that raises the WACC to 13 percent. The most
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likely conclusion is that for Van der Welde:

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A. the company’s prospects are improving.

B. equity financing is cheaper than debt financing.
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C. the company’s debt/equity ratio has moved beyond the optimal range.
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Q-67. Company A has 25% debt and 75% equity in its capital structure. Management decides
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to increase leverage, so it issues more debt and buys back company stock. As a result,
the new capital structure is 50% debt and 50% equity. Which of the following statements
is true in perfect capital markets? example
A. After refinancing, the company is worth more because leverage has increased.
B. After refinancing, the company is worth less because there is a greater chance of bankruptcy.
C. Neither is true.
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4.23. Optimal and Target Capital Structure
4.23.1.
4.23.1.1. Costs of financial distress

➢ During the downward economy, earnings are magnified downward during
economic slowdowns.
➢ Lower or negative earnings put companies under stress, and this financial distress
adds to companies.
➢ Companies whose assets have a ready second market have lower cost associated
with financial distress
◼ Companies with relatively marketable tangible assets incur lower costs from
financial distress;
◼ Companies with few tangible assets have less to liquidate and therefore
have a higher cost associated with financial distress.
4.23.1.2. Static Trade-Off Theory
➢ The static trade-off theory is a theory pertaining to a company’s optimal capital
structure;
➢ The optimal level of debt is found at the point where additional debt would cause
the costs of financial distress to increase by a greater amount than the benefit of
the additional tax shield.
VL = VU + (t  d ) − PV (Costs of Financial Distress)
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➢ With increase in financial leverage

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◼ The tax shield add value to the firm;

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◼ The impact of cost of financial distress, agency cost and cost of asymmetric
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reduce the firm value

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➢ Unlike the MM proposition of no optimal capital structure, or a structure with

almost all debt, static trade-off theory puts forth an optimal capital structure with
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an optimal proportion of debt.
◼ Once the value adding from tax shield and value reduction from these costs
are balanced, the company reaches a max value with lowest cost of capital
→ optimal capital structure.
4.23.1.3. Capital structure
➢ The theoretical point at which the value of the company is maximized is known
as the optimal capital structure.
➢ When a company recognizes its optimal capital structure, it may adopt it as its
target capital structure. But target capital structure may or may not equal to the
optimal capital structure.
➢ Actual capital structure is set for a particular project, while targe capital structure
is measured at the consolidated company level.
4.23.1.4. Agency costs
➢ Agency costs are the incremental costs arising from conflicts of interest when
an agent makes decisions for a principal.
◼ Agency costs to equity
◼ Smaller stake the mangers have, HIGHER cost;
◼ Net agency cost of equity consist of three components
◼ Monitoring costs are the costs borne by owners to monitor the management
of the company;
◼ Bonding costs are the costs borne by management to assure owners that
they are working in the owners’ best interest;
◼ Residual losses are the costs incurred even when there is sufficient
monitoring and bonding, because monitoring and bonding mechanisms are
not perfect.
◼ The better the company is governed, the lower agency cost;
◼ The increase in use of debt vs. equity, decrease the agency cost.
4.23.1.5. Cost of asymmetric information
➢ The provider of both debt and equity capital demand higher returns from
companies with higher asymmetry in information because there is a great
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likelihood of agency costs.

4.23.1.6. Pecking order theory
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➢ Pecking order
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◼ Managers prefer internal financing;

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◼ If internal financing is insufficient, managers next prefer debt;

◼ The final choice is equity.
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➢ Based on the manager’s choice of financing method, the signal can be read;
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4.23.2.
Q-68. According to the static trade-off theory:( )
A. debt should be used only as a last resort.

B. companies have an optimal level of debt.
C. the capital structure decision is irrelevant.
Q-69. Which of the following is least likely an appropriate method for an analyst to estimate a
firm's target capital structure?(notes)
A. Use the firm's current proportions of debt and equity based on market values, with an
adjustment for recent trends in its capital structure.
B. Use average capital structure weights for the firm's industry, based on book values of debt
and equity.
C. Use the firm's current capital structure, based on market values of debt and equity.
Q-70. To determine their target capital structures in practice, it is least likely that firms will:
A. use the book value of their debt to make financing decisions.
B. match the maturities of their debt issues to specific firm investment
C. determine an optimal capital structure based on the expected costs of financial distress.
Q-71. The pecking order theory of financial structure decisions:

A. is based on information asymmetry.
B. suggests that debt is the first choice for financing an investment of significant size.
C. suggests that debt is the riskiest and least preferred source of financing.
Q-72. Compared with managers who do not have significant compensation in the form of stock
options, managers who have such compensation will be expected to favor:
A. less financial leverage.
B. greater firm risk.
C. issuance of common stock.
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4.24. Leverage
4.24.1.
4.24.1.1. Salerisk, operating risk&financial risk

➢ Business risk is the risk associated with operating earnings (EBIT) and results from
a combination of sales risk and operating risk.
◼ Sales risk: uncertainty with respect to the price and quantity of goods and
services;
◼ Operating risk is attributed to the use of fixed costs in operations;
➢ Financial risk is associated with the use of debt.
4.24.1.2. Leverage
➢ Leverage is associated with the use of fixed costs.
➢ financial expenses fixed costs operating financial.
➢ Degree of operating leverage (DOL)
◼ Δ% EBIT / Δ% units sold. 1% operating income
∆𝐸𝐵𝐼𝑇/𝐸𝐵𝐼𝑇
◼ DOL =
∆𝑄/𝑄
𝑄×(𝑃−𝑉)
◼ DOL =
𝑄×(𝑃−𝑉)−𝐹
➢ Degree of financial leverage (DFL)
◼ Δ% net income / Δ% EBIT. EBIT 1%
∆𝐸𝑃𝑆/𝐸𝑃𝑆
◼ DFL = ∆𝐸𝐵𝐼𝑇/𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇
◼ DFL = 𝐸𝐵𝐼𝑇−𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
➢ Degree of total leverage

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◼ Δ% net income / Δ% units sold. 1%

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∆𝐸𝑃𝑆/𝐸𝑃𝑆
◼ DTL = = 𝐷𝑂𝐿 × 𝐷𝐹𝐿
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∆𝑠𝑎𝑙𝑒𝑠/𝑠𝑎𝑙𝑒𝑠
𝑄×(𝑃−𝑉)
◼ DTL = 𝑄×(𝑃−𝑉)−𝐹−𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
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4.24.2.
Q-73. Business risk is best described as resulting from the combined effects of a firm's:
A. financial risk and sales risk.
B. sales risk and operating risk.
C. operating risk and financial risk.
Q-74. Which of the following statements about capital structure and leverage is most accurate?
A. Financial leverage is directly related to operating leverage.
B. Increasing the corporate tax rate will not affect capital structure decisions.
C. A firm with low operating leverage has a small proportion of its total costs in fixed costs.
Q-75. A company has decided to switch to using accelerated depreciation from straight-line
depreciation. Holding other factors constant, the degree of total leverage will most likely
A. increase.
B. decrease.
C. not change.
Q-76. The following information is available for a firm:

Unit 5 million
Total variable cost 40 million
Total fixed cost 25 million
Price 80
Interest 35 million
If sales increase by 15%, the net income will: 1906
A. Increase by 18%.
B. Decrease by 18%.
C. Increase by 15%.
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Q-77. The unit contribution margin for a product is $30. A firm’s fixed costs of production of
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up to 300,000 units is $600,000. The degree of operating leverage (DOL) is most likely
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the lowest at which of the following production levels (in units)?

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A. 150,000
B. 200,000
C. 250,000
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Q-78. A company has decided to switch to using accelerated depreciation from straight-line
depreciation. Holding other factors constant, the degree of total leverage (DTL) will most
likely:
A. decrease.
B. not change.
C. increase.
Q-79.
Income Statement Millions ($)
Revenues 10.0
Variable operating costs 4.5
Fixed operating costs 1.8
Operating income 3.7
Interest 1.0
Taxable income 2.7
Tax 1.0
Net income 1.7
The degree of financial leverage (DFL) is closest to:
A. 2.1.
B. 1.7.
C. 1.4.
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4.25. Breakeven Points
4.25.1.
4.25.1.1. Breakeven point &operating breakeven point

➢ Breakeven point: the level of sales that a firm must generate to cover all of its
fixed and variable costs.
Fixed operating cost+fixed financial cost
◼ Q BE = (breakeven point)
P-V
➢ Operating breakeven point: operating breakeven quantity of sales that only
consider fixed operating costs and ignore fixed financing cost
Fixed operating cost
◼ Q OBE = (operating breakeven point)
P-V
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4.25.2.
Q-80. If the degree of financial leverage (DFL) is 1.00, the operating breakeven point compared
with the breakeven point is most likely:

A. lower.
B. the same.
C. higher.
Q-81. A company’s EBIT remains the same. The degree of financial leverage of changes from
1.2 to 1.3, the operating break point would be :
A. Higher.
B. Lower.
C. The same.
Q-82. Myundia Motors now sells 1 million units at $3,529 per unit. Fixed operating costs are
$1,290 million and variable operating costs are $1,500 per unit. If the company pays $410
million in interest, the levels of sales at the operating breakeven and breakeven points
are, respectively:
A. $1,500,000,000 and $2,257,612,900.
B. $2,243,671,760 and $2,956,776,737.
C. $2,975,148,800 and $3,529,000,000.
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Solutions
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4. Corporate Issuers
4.26.
Solution: B.
Both sole proprietorships and general partnerships have no legal identity, with the business
considered an extension of the owner in a sole proprietorship and the partnership agreement
setting ownership in a general partnership. Both sole proprietorships and limited partnerships have
similar tax structures, with all profits taxed as personal income. But in relation to liability, while
general partners have unlimited liability, shareholders of corporations are granted limited liability.
Solution: B.
Leveraged buyouts can result in a public company going private. Direct listings and special purpose
acquisition companies are methods for a private company to go public.
Solution: A
Assuming a company is repaying interest and principal in full and on time, debt holders have no
further claims. Equity holders benefit from company growth.
Solution: A.
Unlike civil law systems, common law systems provide judges with the ability to create law by
setting precedents that are followed in subsequent cases. Shareholders are viewed as better
protected under common law because judges may rule against management actions in situations
that are not specifically addressed by statutes.
Under CEO duality, the CEO also serves as chairperson of the board. All else equal, this decreases
the protection of shareholder interests in favor of those of management.
Stakeholder theory incorporates the interests of non-shareholders such as customers, suppliers,
and employees. This inevitably dilutes the focus on shareholders.
Solution: A.
Negative screening, which refers to the practice of excluding certain sectors, companies, or
practices that violate accepted standards in such areas as human rights or environmental concerns,
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Solution: A.
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Under appropriate corporate governance procedures, the compensation committee should link
compensation with long-term objectives.
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Solution: A.
Shareholder and manager interests can diverse with respect to risk tolerance. In the same cases,
shareholders with diversified investment portfolios can have a fairly high tolerance because
specific company risk can be diversified away. Managers are typically more risk averse in their
corporate decision making to better project their employment status.
Solution: A.
In statutory voting, each share represents one vote, which is least beneficial for shareholders with
a small number of shares.
Solution: C.
Governance arrangements that help protect creditor rights can reduce a company’s cost of debt
and default risk.
Solution: C
Shareholders own shares of stock in the company, and their wealth is directly related to the
market value of the company.
Creditors are usually not entitled to any additional cash flows (beyond interest and debt
repayment) if the company’s value increases.
While customers may have an interest in the company’s stability and long-term viability, they do
not benefit directly from an increase in a company’s value.
Solution: B
Where compensation, particularly if it is excessive, does not include an adequate amount of stock
grants or options, the risk tolerance of directors and managers may be low because directors and
managers may be inclined to give up taking risks that create value for the company so as to not
jeopardize the compensation they have been receiving.
Solution: B
Under dual-class share systems, company founders or insiders may control board elections,
strategic decisions, and other significant voting matters.
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Conflicts of interest between management and stakeholders are more likely than with single-
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share structures because of the potential control element under dual systems.
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Solution: C
In this ownership structure, the controlling shareholder’s power is likely more influential than
that of minority shareholders. Thus, the controlling shareholder may be able to exploit its
position to the detriment of the interests of the remaining shareholders.
Choices A and B are incorrect because the ownership structure in and of itself is unlikely to create
material conflicts between shareholders and regulators or shareholders and managers.
Solution: C
Detailed forecasts of revenue in expenses would be in a financial plan, but typically not in a
business model. A firm’s largest customers and information about its workforce and its value are
likely elements of a business model.
Solution: A
Firms with a weak competitive position have more risk than firms with competitive advantages of
large scale and brand name recognition. Uncertainty about macroeconomic variables, such as an
exchange rate, and the effects of demographic trends are risks considered to be external to the
firm.
Solution: C.
Regulatory, safety, and environmental projects are often mandated by governmental agencies.
They may generate no revenue and might not be undertaken by a company maximizing its own
private interests. For example, a corporation may be required to install equipment to meet a
regulatory standard, and the cost of satisfying the standard is born by the corporation. In this case,
the corporation selects the lowest cost alternative that meets the requirement, i.e., the alternative
with the least negative net present value.
Solution: B.
All of the incremental cash flows arising from a project should be analyzed on an after-tax basis.
Only sunk costs should be ignored in a project’s cash flow estimation, but not any externalities.
Sunk costs cannot be recovered once they have been incurred. Externalities (both positive and
negative ones) are the effects of an investment decision on other things beside the investment
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Financing costs like interest costs are excluded from calculations of operating cash flows. The
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financing costs are reflected in the required rate of return for an investment project. If financing
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Solution: C.
The cost of the marketing survey should not be included because it is a sunk cost; it will be incurred
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whether they decide to do the project or not. The decrease in sales of their current sauce if the
spicier version is introduced (cannibalization) should be considered in the analysis. The cost of
recipe development should be included because it will only be incurred if they decide to go ahead
with the introduction of the new spicier sauce.
Solution: C.
Investments related to new products or services expose the company to even more uncertainties
than expansion projects. These decisions are more complex and will involve more people in the
decision-making process.
Replacement of worn out equipment is simply an improvement to the existing project with
recurring revenues.
Investments related to new products or services expose the company to even more uncertainties
than expansion projects. These decisions are more complex and will involve more people in the
decision-making process.
Solution: A.
The IRR is the discount rate that makes the NPV = 0. Because the cash flow stream is in perpetuity,
it can be solved as follows:
0 = –270 + (30/IRR)
IRR = 11.1%
Solution: A.
The company should choose the combination of projects that maximizes net present value (NPV)
subject to the budget constraint of $1,100.
Project Investment required NPV decision
1+2 1100 200
1+3+4 1100 200
2+3+4 1000 200 NPV=$200with the least investment
Solution: B.
The NPV of project A is €3,561.18:
:
690 1,698 1,270 7,290

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3,561.18 = -4,900 + + + +
(1.08) (1.08)2 (1.08)3 (1.08)4
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The NPV of Project B is €3,530.73:

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690 1,698 2,102 6,350

3,530.73 = -4,900 + + + +
(1.08) (1.08)2 (1.08)3 (1.08)4
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Solution: A.
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Since all of Bearing’s projects have a positive NPV, they are all providing a return that is
greater than the opportunity cost of capital. Therefore, the ROIC must be greater than the
COC.
Solution: C.
For a project with normal cash flows, the NPV profile intersects the horizontal axis at the point
where the discount rate equals the IRR. The crossover rate is the discount rate at which the NPVs
of the projects are equal. Although it is possible that the crossover rate is equal to each project’s
IRR, it is not a likely event. It is also possible that the IRR is equal to the WACC, but that scenario is
not the most likely one.
The crossover rate is the discount rate at which the NPVs of the projects are equal. While it is
possible that the crossover rate is equal to each project’s IRR, it is not a likely event.
The project’s net present value (NPV) occurs when the NPV profile intersects the vertical axis or
when the discount rate = 0.
Solution: C.
Discount rates of 0 percent and approximately 61.8 percent both give a zero NPV.
Rate 0% 20% 40% 60% 61.8% 80% 100%
NPV 0.00 4.40 3.21 0.29 0.00 —3.02 —6.25
Solution: C.
Conflicting decision rules based on the NPV and IRR methods are related to the reinvestment rate
assumption, the timing of the cash flows, or the scale of the projects. Differing required rates of
return are not related to conflicting NPV and IRR decisions.
Solution: B.
The IRR would stay the same because both the initial outlay and the after-tax cash flows double,
so that the return on each dollar invested remains the same. All of the cash flows and their present
values double. The difference between total present value of the future cash flows and the initial
outlay (the NPV) also doubles.
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Solution: B.
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The value of a company is the value of its existing investments plus the net present values of all of
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its future investments. The NPV of this new plant is £150 million – £100 million = £50 million. The
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price per share should increase by NPV per share or £50 million/100 million shares = £0.50 per
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share. As the new plant’s profitability is less than expectations, the NPV per share (and hence the
increase in the stock price) should therefore be slightly below £0.50 per share.
It is only new plant’s profitability that is below the average not the overall. The company value
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should not fall below £15 per share, all things being equal.
Solution: C.
The project described has a production-flexibility regarding the level of production. Other flexibility
options might be to produce a different product or to use different inputs at some future date.
Including the value of real options can improve the NPV estimates for individual projects.
Solution: B.
The option to abandon the project and receive the market value of the facility if actual cash flows
are less than expected over the first two years can be viewed as a valuable put option that should
be included in the calculation of the project's NPV.
Solution: B
The NPV, including the real option, should be:
Project NPV
= NPV (based on DCF alone) – Cost of options + Value of options.
Project NPV = –0.40 million – 0.30 million + 1.20 million
= EUR0.50 million.
Without the flexibility offered by the real option, the plant is unprofitable. The real option to
adapt to cheaper energy sources adds enough to the value of this investment to give it a positive
NPV. The company should undertake the investment, which would add to its value.
Solution: B.
A line of credit where the borrower can draw funds as they need them and repay them when they
have the funds available to do so is called a revolving line of credit.
Solution: C.
Although accounts payable do not charge an explicit interest rate, the cost of accounts payable is
reflected in the costs of the services or products purchased and in the costs of any discounts not
taken. Accounts payable can have a very high implicit cost. Similarly, equity financing is not free.
A required return is expected on shareholder financing just as on any other form of financing.
:
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Solution: A.
教
GF must issue 19 million of bonds.

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Amount
Source
金
(local, millions)
Accounts payable 6
81-89
Bank loan against receivables 8
Short-term note 14
Net income + depreciation –dividends 28
Total sources 56
The firm requires 75 million of financing in local currency terms. Given the planned sources (before
bond financing or repurchases) total 56 million, GF will need to issue 19 million of new bonds.
Solution: B
Financing an increase in a current asset with long-term borrowing is an example of conservative
working capital management. The other choices describe decreases in current assets and therefore
more likely represent aggressive working capital management.
Solution: B.
Operating cycle = Number of days of inventory + Number of days of receivables.
Cash conversion cycle = Operating cycle − Number of days of payables.
Company Industry
Number of days receivables 365/5.6 = 65 days 365/6.5 = 56 days
Number of days inventory 365/4.2 = 87 days 365/4.0 = 91 days
Operating cycle 65 + 87 = 152 days 147 days (given)
Longer
Cash conversion cycle 124 days (given) 147 − 36 = 111
Longer
Therefore, both the operating and cash conversion cycles are longer for the company.
Solution: C.
A “pull” on liquidity occurs when disbursements are made too quickly (e.g.,current liabilities are
paid instead of being held or when credit availability is reduced or limited). A “drag” on liquidity
occurs when receipts lag (i.e., non-cash current assets do not convert to cash quickly).
Consequently, a reduction in a credit line is a “pull” on liquidity.
:
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Solution: A.
教
The cash conversion cycle is equal to the operating cycle minus the number of days of payables. If
程
Quixote is extending the time it takes to pay its suppliers, its number of days of payables will
金
increase, and its cash conversion cycle will decrease. Its operating cycle (days of inventory plus days
of receivables) is unaffected by the increase in days of payables. Changes in inventory or
receivables management would affect both the operating cycle and the cash conversion cycle.
82-89
Solution: B.
Renegotiating debt contracts is a secondary source of liquidity because it may affect the company’s
operating and/or financial positions.
Increasing cash flow management efficiency is a primary source of liquidity.
Increasing bank lines of credit is a primary source of liquidity.
Solution C
The company would likely need more working capital to support the expected increase in
required inventory and accounts receivable resulting from an increase in sale.
Solution: C
The increase in credit limits is not a pull on liquidity but is in fact the opposite: it provides
liquidity.
Solution: B.
As the target capital weights are not given, you can use market value weights to compute the WACC.
The market value weights for debt, preferred stock and equity are 0.2667, 0.0667, and 0.6667
respectively.
WACC= ( wd ) kd (1-t )  + ( wps )(kps ) + ( wce )(ks )

= 0.2667  8% (1 − 0.4 ) + 0.0667  10% + 0.6667  12% = 9.95%
Solution: B.
B is correct.
WACC = wdrd (1 – t) + were , where wd + we = 1
7.11 = (1 – we ) × 6 × (1 – 0.4) + we ×9
we = 65%
Solution: B.
An external analyst does not know a company’s actual target capital structure. Consequently, the
analyst should rely on market value (not book value) weights for the components of the company’s
:
育
current capital structure.

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Solution: C.
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If the systematic risk of the project is above average relative to the company’s current portfolio of
金
projects, an upward adjustment is made to the company’s MCC or WACC.
83-89
Solution: C.
The bond rating approach depends on knowledge of the company's rating and can be compared
with yields on bonds in the public market.
Solution: B
The annual after-tax cost of debt is the after tax annual yield to maturity (YTM). Find the YTM by
using a financial calculator as follows:
PV = –1,030.34, FV = 1,000, N = 40 (20 × 2), PMT = 31 (0.062 × 1,000 × 0.5), compute i.
i = 2.97 semiannually
Annually, YTM = 2.97 × 2 = 5.94
Therefore, the associated after-tax value = 0.0428 = 0.0594 × (1 – 0.28).
Solution: B.
DCF:
Re = dividend yield + g
g=ROE*(1-payout ratio) = (1-0.5)*20% = 10%.
The expected dividend yield is 1.5×1.1/ 25 =6.6%.
Re=6.6% + 10% = 16.6%.
CAPM:
Re=Rf+β ×[E(Rm)-Rf]=5% + 1.2 × (15%-5%) = 17%
Solution: A.
A company’s cost of equity is often used as a proxy for the investor’s minimum required rate of
return because it is the minimum expected rate of return that a company must offer its investors
to purchase its shares in the primary market and to maintain its share price in the secondary market.
Using the CAPM, the company’s cost of equity = 3.50% + 1.80(5.25%) = 12.95%.
Comparing this result with the fund manager’s required rate of return of 13.60%, the fund manager
should not invest in the stock.
The company’s WACC, though less than the required rate of return, is not the appropriate criterion
for decision to invest in the stock.
Even though the company’s ROE (20/140 = 14.29%) is greater than the fund manager’s required
:
rate of return, it is not the appropriate criterion for decision to invest in the stock.
育
教
Solution: A.
程
The capital asset pricing model uses the firm’s equity beta, which is computed from a market model
金
regression of the company's stock returns against market returns.
84-89
Solution: B.
First, determine the yield to maturity, which is the discount rate that sets the bond price to
$1,105.94 and is equal to 7%. This calculation can be done with a financial calculator:
FV = –$1,000, PV = $1,105.94, N = 20, PMT = –$80, solve for i, which will equal 7%.
The bond-yield-plus-risk-premium approach is calculated by adding a risk premium to the cost of
debt (i.e., the yield to maturity for the debt), making the cost of equity 12.00% (= 7% +5%).
Solution: A.
The yield to maturity on a par value bond is the coupon rate of the bond:
rd = 9%
DP $1.2
rp = = = 15%
PP $8
re = RF +   E ( RM ) − RF  = 5% + 1.2(12%) = 19.4%
WACC = wd rd (1 − t ) + wp rp + we re
WACC = 40%  9%  (1 − 30%) + 10%  15% + 50%  19.4% = 13.72%
Solution: B.
βequity = β asset × [1+(1−tax rate)×D/E]
If the tax rate increases, then the bracketed term (1 − tax rate) decreases, making the equity beta
decrease because the asset beta is unchanged.
Solution: C.
Inferring the asset beta for the public company: unlevered beta = 1.75/[1 + (1 - 0.35) (0.90)] = 1.104.
Relevering to reflect the target debt ratio of the private firm: levered beta = 1.104 × [1 + (1 - 0.30)
(1.00)] = 1.877.
Solution: B.
The debt-to-equity ratio of the new product should be used when making the adjustment from the
asset beta, derived from the comparable, to the equity beta of the new product.
:
Solution: B.
育
Asset risk does not change with a higher debt-to-equity ratio. Equity risk rises with higher debt.
教
程
Solution: C.
金
Flotation costs are an additional cost of the project and should be incorporated as an adjustment
to the initial-period cash flows in the valuation computation.
Expensing is an accounting treatment of the costs, not a capital budgeting treatment.
85-89
Including the flotation cost in the estimated cost of capital is theoretically incorrect. By doing so
we are adjusting the present value of the future cash flows by a fixed percentage, i.e., the adjusted
cost of capital.
Solution: A.
During the start-up stage a firm is un1ikely to have positive earnings and cash flows or significant
assets that can be pledged as debt collateral, so firms in this stage are typically financed by equity
only.
Solution: A.
The optimal capital structure minimizes the firm's WACC and maximizes the firm's value (stock
price).
Solution: A
While one can often find exceptions, the standard approach to financing a business in such a
highly competitive sector as retail, with negative and/or unpredictable cash flows, is to rely
primarily on equity. Using predominantly equity financing to meet capital needs allows
management to preserve operational and financial flexibility while minimizing the risk of financial
distress associated with debt.
Solution: C
Green Company has fixed assets, for which there is likely to be a ready and liquid market, and
stable cash flows, which are supportive of debt financing. Black Company, a cloud-based software
technology company, is a “capital-light” business, with few fixed assets. Its assets are likely to
consist of mostly human capital. Additionally, servicing a cyclical industry is also likely to lead to
Black Company having low debt.
Solution: B.
Proposition I, or the capital structure irrelevance theorem, states that the level of debt versus
equity in the capital structure has no effect on company value in perfect markets.
:
Solution: C.
育
MM's Proposition 1 (with no taxes) states that capital structure is irrelevant because the decrease
教
in a firm's WACC from additional debt financing is just offset by the increase in WACC from a
程
decrease in equity financing. The cost of debt is held constant and the cost of equity financing
金
increases as the proportion of debt in the capital structure is increased.
Solution: C.
86-89
The cost of equity rises with the use of debt in the capital structure, e.g., with increasing financial
leverage.
Solution: C.
0.10 = (0.50)(0.05)(1 – 0.20) + (0.50)re
re = 0.16 or 16 percent
Solution: C.
If the company’s WACC increases as a result of taking on additional debt, the company has moved
beyond the optimal capital range. The costs of financial distress may outweigh any tax benefits to
the use of debt.
Solution: C
Neither answer is correct. In perfect capital markets, a change in capital structure has no impact
on the value of the company.
Solution: B.
The static trade-off theory indicates that there is a trade-off between the tax shield from interest
on debt and the costs of financial distress, leading to an optimal amount of debt in a company’s
capital structure.
Solution: B.
For an analyst, target capital structure should always be based on market values of debt and equity.
The other two choices are appropriate methods for estimating a firm's capital structure for analysis.
Solution: C.
While it is a useful theoretical concept, in practice determining an optimal capital structure based
on the cost savings of debt and the expected costs of financial distress is not feasible. Because debt
rating companies often use book values of debt, firms use book values of debt when choosing
financing sources. It is common for firms to match debt maturities to the economic lives of specific
investments.
:
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Solution: A.
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Pecking order theory is based on information asymmetry and the resulting signals that different
程
financing choices send to investors. It suggests that retained earnings are the first choice for
金
financing an investment and issuing new equity is the least preferred choice.
Solution: B.
87-89
Given the asymmetric returns on stock options, we would expect managers with significant stock
options in their compensation to favor greater financial1everage and issuance of debt to increase
potential stock price gains. Issuing common stock could decrease the market price of shares, which
would decrease the value of stock options.
Solution: B.
Business risk is the combination of sales risk, which is the variability of a firm's sales, and operating
risk, which is the additional variability in operating earnings (EBIT) caused by fixed operating costs.
Solution: C.
If fixed costs are a small percentage of total costs, operating leverage is low.
Operating leverage is separate from financial leverage, which depends on the amount of debt in
the capital structure. Increasing the tax rate would make the after-tax cost of debt cheaper.
Solution: A.
Based on Equation:
DTL=
Quantity  ( Price -Variable cost )
Quantity  ( Price-Variable cost ) - Fixed costs -Financing costs 
The change to accelerated depreciation increases the fixed costs, making DTL (degree of total
leverage) increase (i.e., the numerator does not change and the denominator decreases).
Solution: A.
𝑄 × (𝑃 − 𝑉𝐶) 5 × (80 − 40/5) 360
DTL = = = = 1.2
(𝑃
𝑄 × − 𝑉𝐶) − 𝐹𝐶 − 𝐼 5 × (80 − 40/5) − 25 − 35 300
Degree of total leverage: Δ% net income / Δ% units sold
Δ% net income=1.2*15% =18%
Solution: C.
Q(P-V)
DOL=
Q(P-V)-F
$30  150,000
DOL (150,000 units ) = = 1.154
( $30  150,000 - $600,000 )
:
育
$30  200,000
DOL ( 200,000 units ) = = 1.111
(  200,000 - $600,000 )
教
$30
$30  250,000
DOL ( 250,000 units ) =
程
= 1.087
( $30  250,000 - $600,000 )
金
The DOL is lowest at the 250,000 unit production level.
88-89
Solution: C.
Q(P-V) ,
Based on the equation : DTL=DOL  DFL=
Q(P-V)-F-I
The change to accelerated depreciation increases the fixed costs, thus making DTL increase
(i.e., the numerator does not change and the denominator decreases).
Solution: C.
EBIT 3.7
DFL = = = 1.37
EBIT − I 3.7 − 1.0
Solution: B.
When DFL = Operating income/Net income = 1.00, Operating income = Net income, meaning the
fixed cost of debt is zero.
The breakeven point is: Fixed costs + Fixed cost of debt/Contribution margin.
Because the fixed cost of debt is zero, the company’s breakeven point becomes fixed
costs/Contribution margin, which is the same as the operating breakeven point.
Solution: C.
The change of DFL from 1.2 to 1.3 means an increase of interest expense, but the change of interest
does not affect operating breakeven point.
Solution: B.
$1290 million
Operating breakeven units = =635,781.173 units
($3,529-$1,500)
Operating breakeven sales =$3,529  635,781.173 units=$2 ,243,671,760
$1290 million+$410 million
Total breakeven= =837,851.1582 units
$3,529-$1,500
Breakeven sales=$3,529  837,851.1582 units=$2,956,776,737
:
育
教
程
金
89-89

CFA一级百题预测 企业理财

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4.

4.1.1.1. Sole Proprietorship

4.1.1.3. Limited Partnership

➢ A limited partnership (E.g. Private Equity)

management of the business.

◆ In most countries, corporations are taxed directly on their profits.

(dividends) that are passed on to them.

➢ Key Features of Corporation

◼ Separate legal identity

structure types? p614 knowledge check

A. Sole proprietorships and general partnerships lack legal identity.

◼ MBO: investors are the company’s current management team.

savings they believe can be realized by taking the company private.

Investor Equity Debt

Return potential Unlimited Capped

Maximum loss Initial investment Initial investment

Investment risk higher Lower

Investment interest Max (net asset– liabilities) Timely repayment

◼ Bondholders prefer management to invest in less risky projects.

Issuer Equity Debt

Capital cost Higher Lower

Creates dilution, may be only option

4.4.1.1. Corporate governance

company’s ability to repay suppliers on time may be affected;

➢ Shareholders and governments or regulators

◼ Bank’s shareholders preferring a lower equity capital base while regulators

prefer a higher capital position.

4.4.1.4. Corporate governance and stakeholder management framework

➢ Legal infrastructure defines rights established by law ;

➢ The governmental infrastructure refers to regulations imposed on companies

4.4.1.5. General meetings

◼ Committee member independence;

◼ Creating nomination procedures and policies;

Recruiting qualified board members;

➢ Benefits of effective governance and stakeholder management

◼ Better operating and financial performance

◼ Lower default risk and cost of debt

◼ Full integration: refers to the inclusion of ESG factors or ESG scores in

◼ Engagement/active ownership investing: refers to using ownership of

company shares or other securities as a platform to promote improved ESG

elections they are least likely to choose? 1906

increase in the market value of the company? p644 example

decides not to pursue the project? example

A. Dual-class share structures can be easily changed over time.

interest are most likely to arise between: example

A. shareholders and bondholders.

C. the controlling shareholder and minority shareholders.

4.5.1.1. Key features of business model

complex aspects of product installation, customization, service, or support.

exclusive relationship with the parent (franchisor) company.

➢ E-commerce Business Models

◼ Crowdsourcing to contribute directly to a product, service, or online

not, other things being equal.

◼ Asset-light business models shift the ownership of high-cost assets to other

◼ Lean startups extend this logic to human resources, outsourcing as many

4.6.1.1. Macro Risks

◼ Lower concentration (i.e., the presence of many small competitors

HHI) is generally associated with a high degree of competitive intensity.

A. competitive position. example

B. exchange rate uncertainty.

4.7.1.1. capital projects

➢ Mandatory investment: regulatory, safety, and environmental project (

CFA一级百题预测企业理财

CFA一级百题预测企业理财