BUS2037 Financial Management
Practice Questions
The questions provided in this sample simply give you an idea how the exam looks like. They do
... [Show More] not
necessarily reflect the focused topics or contents of the true exam paper.
1. Cone Inc. expects to have the following data during the coming year. What is the firm's
expected ROE?
Capital $150,000 Interest rate 8%
Debt/Capital, book value 65% Tax rate 25%
EBIT $25,000
a. 18.67%
b. 23.83%
c. 21.62%
d. 24.57%
ANSWER: d
Capital $150,000 EBIT $25,000
Debt/Capital 65% - Interest = rate × debt = 7,800
EBIT $25,000 Earnings before taxes $17,200
Interest rate 8% - Taxes 4,300
Tax rate 25% Net income $12,900
Debt = (Debt/Capital) × Capital $97,500 NI / Equity = ROE = 24.57%
Equity = Assets – Debt $52,500
2. Dye Industries currently uses no debt, but its new CFO is considering changing the capital
structure to 61.0% debt (wd) by issuing bonds and using the proceeds to repurchase and retire
some common shares so the percentage of common equity in the capital structure (wc) = 1
– wd. Given the data shown below, by how much would this recapitalization change the firm's
cost of equity, i.e., what is rL - rU? Do not round your intermediate calculations.
Risk-free rate, rRF 5.50% Tax rate, T 25%
Market risk prem, RPM 3.00% Current wd 0%
Current beta, bU 1.75 Target wd 61.0%
a. 4.31%
b. 5.23%
c. 7.08%
d. 6.16%
ANSWER: d
Risk-free rate, rRF 5.50% Tax rate, T 25%
Mkt risk prem, RPM 3.00% Current wd 0%
Current beta, bU 1.75 Target wd 61.0%
Target D/E = wd/(1 – wd) 1.56
bL = bU [(1 + (D/E)(1 – T)] 3.80
rU = rRF + bU(RPM ) 10.75%
rL = rRF + bL(RPM ) 16.91%
Change in equity cost = 6.16%
3. Maxwell Feed & Seed is considering a project that has the following cash flow data. What is
the project's IRR? Note that a project's projected IRR can be less than the WACC (and even
negative), in which case it will be rejected.
Year 0 1 2 3 4 5
Cash flows -$6,250 $2,000 $2,025 $2,050 $2,075 $2,100
a. 18.18%
b. 23.11%
c. 17.62%
d. 18.94%
ANSWER: d
Year 0 1 2 3 4 5
Cash flows -$6,250 $2,000 $2,025 $2,050 $2,075 $2,100
IRR = 18.94%
4. LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average
risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%.
Which of the following projects (A, B, and C) should the company accept?
a. Project B, which is of below-average risk and has a return of
8.5%.
b. Project C, which is of above-average risk and has a return of 11%.
c. Project A, which is of average risk and has a return of 9%.
d. None of the projects should be accepted.
ANSWER: a
5. O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.50. What is the
firm's cost of equity from retained earnings based on the CAPM? [Show Less]