D076 Finance Skills for Managers - Set 5 - Part 3

Correct Answer: WACC will decrease

Since the cost of debt is lower than the cost of equity, increasing the proportion of debt in the firms capital structure will reduce the weighted average cost of capital (WACC), assuming the firm does not take on excessive debt that increases risk.

Correct Answer: Market return minus the risk-free rate

In the CAPM formula, the market risk premium is calculated as the market return minus the risk-free rate. It represents the additional return expected for taking on market risk.

Correct Answer: Interest payments on debt are tax-deductible

One of the primary advantages of debt financing is that interest payments are tax-deductible, which reduces the firms taxable income and lowers the overall cost of debt.

Correct Answer: The companys ability to meet interest payments has worsened

A lower TIE ratio indicates that the companys earnings before interest and taxes (EBIT) have declined relative to its interest obligations, suggesting that its ability to meet interest payments has worsened.

Correct Answer: Net Present Value (NPV)

NPV is the best method for accounting for risk, as it uses the discount rate, which can be adjusted to reflect the risk level of the project. Payback Period and Discounted Payback Period do not account for risk adequately, and PI is a ranking tool but may not fully capture risk differences.

Correct Answer: The company has adequate liquidity

A current ratio of 1.2 indicates that the company has slightly more current assets than current liabilities, suggesting it has adequate liquidity to meet its short-term obligations.

Correct Answer: Net Present Value (NPV)

NPV explicitly incorporates the time value of money by discounting future cash flows to the present, making it a superior method compared to Payback Period, which ignores the time value of money.

Correct Answer: The stock is more volatile than the market

A beta of 2.0 indicates that the stock is twice as volatile as the market, meaning it is expected to experience larger fluctuations in response to market movements.

Correct Answer: Accept the project with the higher NPV

When choosing between mutually exclusive projects, the project with the higher NPV should generally be selected because it adds more value to the firm.

Correct Answer: WACC will decrease

Increasing the proportion of debt financing generally reduces WACC, as debt is typically less expensive than equity, especially since interest payments on debt are tax-deductible.