Financial Management and Investment Flashcards

A company has a debt-to-equity ratio of 0.6, an equity beta of 1.4, and a tax rate of 25%. What is the asset (ungeared) beta?

Answer: 1.05

Asset beta = equity beta / [1 + (D/E)(1-T)] = 1.4 / [1 + 0.6 × 0.75] = 1.4 / 1.45 ≈ 1.05.

Which technique adjusts a project's discount rate upward to account for political and country risk when appraising overseas investments?

Answer: Risk-adjusted discount rate

The risk-adjusted discount rate method adds a country risk premium to the base cost of capital to reflect additional sovereign and political risk.

A bond with a face value of $1,000 pays a 6% annual coupon and matures in 5 years. If the required yield is 8%, what is its approximate market price?

Answer: $920.15

The bond trades at a discount because the coupon rate (6%) is below the required yield (8%), giving a price of approximately $920.

Under CAPM, which type of risk is rewarded with higher expected returns?

Answer: Systematic (market) risk

Only systematic risk, measured by beta, is rewarded under CAPM because unsystematic risk can be diversified away in a portfolio.

A firm's shares trade at $50, expected dividend next year is $2.50, and dividends grow at 4% per year. What is the cost of equity using the Gordon Growth Model?

Answer: 9%

Cost of equity = D1/P0 + g = $2.50/$50 + 0.04 = 0.05 + 0.04 = 9%.

Which of the following best describes the Adjusted Present Value (APV) method?

Answer: It separates base-case NPV from financing side effects

APV = base-case NPV (as if all-equity) plus the NPV of financing side effects such as the tax shield on debt.

A project has an initial investment of $500,000 and generates annual after-tax cash flows of $120,000 for 6 years. What is the payback period?

Answer: 4.2 years

Payback = $500,000 / $120,000 = 4.17 years, approximately 4.2 years.