finance data bank

Multiple Choice and True/False Questions

12.1 Financial Globalization and Strategy

1) Which of the following is NOT a key variable in the weighted average cost of capital (WACC) equation?

A) the market value of equity

B) the market value of debt

C) the risk-free rate of return

D) the marginal tax rate

2) The weighted average cost of capital (WACC) is

A) the required rate of return for all of a firm's capital investment projects.

B) the required rate of return for a firm's average risk projects.

C) not applicable for use by MNE.

D) equal to 13%.

3) Which of the following is NOT a key variable in the weighted average cost of capital (WACC) equation?

A) the before-tax cost of debt

B) the risk-adjusted cost of equity

C) the beta of the market portfolio

D) the total market value of the firm's securities

4) Other things equal, an increase in the firm's tax rate will increase the WACC for a firm that has both debt and equity financing.

5) The capital asset pricing model (CAPM) is an approach

A) to determine the price of equity capital.

B) used by marketers to determine the price of saleable product.

C) can be applied only to domestic markets.

D) none of the above.

6) Which of the following is NOT a key variable in the equation for the capital asset pricing model?

A) the risk-free rate of interest

B) the expected rate of return on the market portfolio

C) the marginal tax rate

D) All are important components of the CAPM.

7) ________ risk is a function of the variability of expected returns of the firm's stock relative to the market index and the measure of correlation between the expected returns of the firm and the market.

A) Systematic

B) Unsystematic

C) Total

D) Diversifiable

8) Systematic risk

A) is the standard deviation of a securities returns.

B) is measured with beta.

C) is measured with standard deviation.

D) none of the above.

9) If a firm's expected returns are more volatile than the expected return for the market portfolio, it will have a beta less than 1.0.

10) Which of the following is generally unnecessary in measuring the cost of debt?

A) a forecast of future interest rates

B) the proportions of the various classes of debt a firm proposes to use

C) the corporate income tax rate

D) All of the above are necessary for measuring the cost of debt.

11) The after-tax cost of debt is found by

A) dividing the before-tax cost of debt by (1 - the corporate tax rate).

B) subtracting (1 - the corporate tax rate) from the before-tax cost of debt.

C) multiplying the before-tax cost of debt by (1 - the corporate tax rate).

D) subtracting the corporate tax rate from the before-tax cost of debt.

12) The WACC is usually used as the risk-adjusted required rate of return for new projects that are of the same average risk as the firm's existing projects.

13) A firm whose equity has a beta of 1.0

A) has greater systematic risk than the market portfolio.

B) stands little chance of surviving in the international financial market place.

C) has less systematic risk than the market portfolio.

D) None of the above is true.

14) One of the distinct features of international equity markets is that over the last 100 or so years, the average market risk premium is almost identical across major industrial countries.

15) The difference between the expected (or required) return for the market portfolio and the risk-free rate of return is referred to as ________.

A) beta

B) the geometric mean

C) the market risk premium

D) the arithmetic mean

16) In general the geometric mean will be ________ the arithmetic mean for a series of returns.

A) less than

B) greater than

C) equal to

D) greater than or equal to

17) The beginning share price for a security over a three-year period was $50. Subsequent year-end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric average annual rate of return for this stock were

A) 9.30% and 8.78%, respectively.

B) 9.30% and 7.89%, respectively.

C) 9.30% and 7.03%, respectively.

D) 9.30% and 6.37%, respectively.

18) If a company fails to accurately predict it's cost of equity, then

A) the firm's wacc will also be inaccurate.

B) the firm may not be using the proper interest rate to estimate NPV.

C) the firm my incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.

D) all of the above are true.

19) Ready Supply Co. has a cost of debt of 8%. The risk-free rate of interest is 3% and the expected return on the market portfolio is 10%. If the firm has a beta of 0.90 and an effective tax rate of 30% with a capital structure that is 40% debt and 60% equity, what is the firm's weighted average cost of capital?

A) 7.82%

B) 9.30%

C) 5.60%

D) 8.00%

20) Johnson Fuel Systems has a weighted average cost of capital of 7.35%. Estimate Johnson's cost of equity given the following information: The firm's effective tax rate is 25%, they have an equal mix of debt and equity, the required return on the market portfolio is 9%, Johnson has a before-tax cost of debt of 6%, and the risk-free rate of return is 3%.

A) 2.25%

B) 5.10%

C) 9.00%

D) 10.20%

21) LipTea Incorporated purchases raw materials and has processing plants around the world. They also have an international market for their product. Because of their presence in so many countries LipTea has the ability to raise capital around the world in several different markets. LipTea is truly an MNE. If the firm has an average pre-tax cost of debt of 8%, a cost of equity of 13%, and an average tax rate of 40%, what is their after-tax cost of debt?

A) 3.2%

B) 8.0%

C) 4.8%

D) 10.5%

22) LipTea Incorporated purchases raw materials and has processing plants around the world.

The firm has an average pre-tax cost of debt of 8%, an average tax rate of 40%, and an international equity beta of 1.2. The risk-free rate of return is anticipated to be 4% and the return to the international market portfolio to be 12%. If the firm finances 40% with debt and 60% with equity, what is the after-tax WACC?

A) 10.08%

B) 12.96%

C) 11.36%

D) 10.50%

23) LipTea Incorporated purchases raw materials and has processing plants around the world.

The standard deviation of the firm’s equity returns is 1.2 times as great as the market’s standard deviation of returns. If the correlation of LipTea’s returns with the market’s is 0.80, what is the systematic risk of the firm?

A) 1.50

B) 1.20

C) 0.96

D) There is not enough information to answer this question.

24) LipTea Incorporated purchases raw materials and has processing plants around the world.

The firm finances 30% of its assets with debt and 70% with equity, has a 30% average tax rate, and can issue bonds at a pre-tax rate of 7%. Their standard deviation of returns is roughly 1.50 times as great as the market’s returns, and has a correlation with the market of 0.45. If the risk-free rate of return is 5% and the expected return on the international market portfolio is 14%, what is the firm’s WACC?

A) 7.75%

B) 8.38%

C) 12.24%

D) There is not enough information to answer this question.