CPA Business Environment and Concepts (BEC) : Financial Management Formulas
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Example Questions
Example Question #1 : Financial Management Formulas
Which one of a firm's sources of new capital usually has the lowest after-tax cost?
Retained earnings
Bonds
Preferred stock
Common stock
Bonds
Debt is a cheaper source of financing than equity. In addition, there is a tax deduction for interest paid on debt.
Example Question #1 : Weighted Average Cost Of Capital Formula
Which of the following rates is most commonly compared to the internal rate of return to evaluate whether to make an investment?
Short term rate on US Treasury bonds
Weighted average cost of capital
Long term rate on US Treasury bonds
Prime rate of interest
Short term rate on US Treasury bonds
WACC is used as the hurdle rate within capital budgeting techniques. Investments that provide a return that exceeds the WACC should continuously add to the value of the firm.
Example Question #2 : Weighted Average Cost Of Capital Formula
Which one of the following factors might cause a firm to increase the debt in its financial structure?
An increase in the PE ratio
Increased economic uncertainty
A decrease in the times interest earned ratio
An increase in the corporate income tax rate
An increase in the corporate income tax rate
Interest on debt financing is tax-deductible whereas dividends from equity are not. An increase in tax rates might cause a firm to increase debt financing.
Example Question #2 : Financial Management Formulas
The marketable securities with the least amount of default risk are:
Bankers acceptances
Repurchase agreements
Federal government agency securities
US Treasury securities
US Treasury securities
Default risk is the risk that the security will not be paid. US Treasury securities are issued by the Treasury Department which has no risk of non payment.
Example Question #2 : Financial Management Formulas
Which of the following measurement models is being used if a calculation includes risk-free rate, beta coefficient, rate of return, and required rate of return?
Overall cost of capital
Capital asset pricing
Constant growth
Weighted marginal cost of capital
Capital asset pricing
These factors are included in the calculation of CAPM.
Example Question #1 : Weighted Average Cost Of Capital Formula
Which of the following would never be included in the WACC formula?
Required rate of return
Tax rate
Summed market values of a firm's capital structure
Risk
Risk
Risk is not assessed in calculating the WACC. WACC is used to determine the cost of financing for a firm.
Example Question #1 : Capm Formula
The overall cost of capital is the:
Cost of the firm's equity capital at which the market value of the firm will remain unchanged
Minimum rate a firm must earn on high risk projects
Rate of return on assets that covers the costs associated with the funds employed
Maximum rate of return on assets
Rate of return on assets that covers the costs associated with the funds employed
Firms must at least earn a rate of return on investments equal to their cost of capital, otherwise the investments are losing money and decreasing value.
Example Question #2 : Capm Formula
ABC company is determining how to finance some long term debt projects. ABC has decided it prefers the benefits of no fixed charges, no fixed maturity date, and an increase in the creditworthiness of the company. Which of the following would best meet ABC's financing requirements?
Common stock
Short term debt
Bonds
Long term debt
Common stock
Common stock does not require payment, does not mature, and decreases the debt to equity ratio as there is no debt incurred.
Example Question #1 : Financial Management Formulas
Using the capital asset pricing model, the required rate of return for a firm with a beta of 1.25 when the market return is 14% and the risk-free rate is 6% is:
16%
7.50%
14%
17.50%
16%
Cost of retained earnings=6% + 1.25 (14% - 6%) = 16%
Example Question #1 : Financial Management Formulas
The cost of debt most frequently is measured as:
Actual interest rate minus tax savings
Actual interest rate
Actual interest rate plus a risk premium
Actual interest rate adjusted for inflation
Actual interest rate minus tax savings
Actual interest rates minus tax savings is the most frequently used measure for cost of debt.
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