CGA CGA Corporate Finance & Capital Markets 1 — Questions and Answers
Question 1: Which capital budgeting method calculates the discount rate at which NPV equals zero?
- Net Present Value
- Internal Rate of Return (Correct answer)
- Payback Period
- Accounting Rate of Return
Correct answer: Internal Rate of Return
The Internal Rate of Return (IRR) is the discount rate that makes the net present value of all cash flows equal to zero.
Question 2: A company has a debt-to-equity ratio of 1.5. If total equity is $400,000, what is total debt?
- $267,000
- $600,000 (Correct answer)
- $400,000
- $1,000,000
Correct answer: $600,000
Total debt = debt-to-equity ratio × equity = 1.5 × $400,000 = $600,000.
Question 3: Which of the following best describes the weighted average cost of capital (WACC)?
- The return required by equity holders only
- The average interest rate on outstanding debt
- The blended cost of all financing sources weighted by their proportion (Correct answer)
- The minimum return required by creditors
Correct answer: The blended cost of all financing sources weighted by their proportion
WACC blends the cost of debt and equity, each weighted by its proportion in the total capital structure.
Question 4: A bond is trading at a premium. Which statement is correct?
- The coupon rate is below the market rate
- The coupon rate equals the market rate
- The coupon rate exceeds the market rate (Correct answer)
- The bond has no par value
Correct answer: The coupon rate exceeds the market rate
A bond trades at a premium when its coupon rate is higher than the prevailing market interest rate, making it more valuable.
Question 5: Under the Modigliani-Miller theorem (no taxes), how does capital structure affect firm value?
- More debt always increases firm value
- Capital structure has no effect on firm value (Correct answer)
- Equity financing maximizes firm value
- Optimal capital structure is all debt
Correct answer: Capital structure has no effect on firm value
In a perfect market without taxes, Modigliani-Miller showed that capital structure is irrelevant to total firm value.
Question 6: Which type of stock gives holders priority over common stockholders in dividend payments?
- Growth stock
- Preferred stock (Correct answer)
- Treasury stock
- Blue-chip stock
Correct answer: Preferred stock
Preferred stockholders receive dividends before common stockholders and typically have a fixed dividend rate.
CGA CGA Corporate Finance & Capital Markets 1
Which capital budgeting method calculates the discount rate at which NPV equals zero?