IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 741:

  the rational decision-making process is most often typified by

  A. Perfect information.

  B. Bounded rationality.

  C. Selection of optimum decisions.

  D. Choice of the least risky solution.

  Correct Answer: B

  Rarely can decision makers know all possible courses of action, the variables that will affect them, and their precise outcomes. Decision makers face limitations of time, money, technical methods, and creativity. Accordingly, they are restricted to a bounded rationality. Because rationality is inherently limited, decisions invariably 1entail some risk.

• Question 742:

  An organization's executive committee, meeting to solve an important problem, spent 30 minutes analyzing data and debating the cause of the problem. Finally, they agreed and could move onto the next step. Possible steps in the creative problem-solving process are listed below. Which step should the committee perform next?

  A. Select a solution.

  B. Generate alternative solutions.

  C. Identify the problem.

  D. Consider the reaction of competitors to various courses of action.

  Correct Answer: B

  Robert Kreisler [Management, 9th ed., Houghton-Mifflin (2004), page 268] states that "managerial problem solving consists of a four-step sequence: (1) identifying the problem, (2) generating alternative solutions,

  (3) selecting a solution, and (4) implementing and evaluating the solution." In the first step, management determines what the actual situation is, what the desired situation is, and the reason for the difference.

• Question 743:

  Datacomp Industries, which has no current debt, has a beta of .95 for its common stock. Management is considering a change in the capital structure to 30% debt and 70% equity This change would increase the beta on the stock to 1.05. and the after-tax cost of debt will be 75%. The expected return on equity is 16%, and the risk-free rate is 6%. Should Datacomp's management proceed with the capital structure change?

  A. No, because the cost of equity capital will increase.

  B. Yes, because the cost of equity capital will decrease.

  C. Yes, because the weighted-average cost of capital will decrease.

  D. No, because the weighted-average cost of capital will increase.

  Correct Answer: C

  The important consideration is whether the overall cost of capital will be lower for a given proposal. According to the Capital Asset Pricing Model, the change will result in a lower average cost of capital For the existing structure, the cost of equity capital is 15.5% [6% + 95(16% -- 6%)1, Because the company has no debt, the average cost of capital is also 15.5%. Under the proposal, the cost of equity capital is 16.5% [6% + 1.05(16% -- 6%)]. and the weighted average cost of capital is 13.8% [.3(075) + 7(165)]. Hence, the proposal of 13.8% should be accepted

• Question 744:

  The firm's marginal cost of capital

  A. Should be the same as the firm's rate of return on equity.

  B. Is unaffected by the firms capital structure.

  C. Is inverse' related to the firm's required rate of return used in capital budgeting.

  D. Is a weighted average of the investors' required returns on debt and equity

  Correct Answer: D

  The marginal cost of capital is the cost of the next dollar of capital. The marginal cost continually increases because the lower cost sources of funds are used first. The marginal cost represents a weighted average of 1both debt and equity capital.

• Question 745:

  If a company has a higher dividend-payout ratio, then, if all else is equal, it will have

  A. A higher marginand cost of capital

  B. A lower marginal cost of capital.

  C. A higher investment opportunity schedule.

  D. A lower investment opportunity schedule.

  Correct Answer: A

  The higher the dividend-payout ratio, the sooner retained earnings are exhausted and the company must seek external financing. Assuming the same investments are undertaken, the result is a higher marginal cost of capital because lower-cost capital sources will be used up earlier.

• Question 746:

  When a company increases its degree of financial leverage (DFL).

  A. The equity beta of the company falls.

  B. The systematic risk of the company falls.

  C. The systematic risk of the company rises.

  D. The standard deviation of returns on the equity of the company rises.

  Correct Answer: D

  The DFL equals the percentage change in earnings available to common shareholders divided by the percentage change in net operating income When the DFL rises. fixed interest charges and the riskiness of the firm rise. As a result, the variability of the returns to equity holders will increase. In other words, the standard deviation of returns on the equity of the company rises.

• Question 747:

  A company has made the decision to finance next year's capital projects through debt rather than additional equity. The benchmark cost of capital for these projects should be

  A. The before-tax cost of new-debt financing.

  B. The after-tax cost of new-debt financing

  C. The cost of equity financing.

  D. The weighted-average cost of capital.

  Correct Answer: D

  A weighted average of the costs of all financing sources should be used, with the weights 11determined by the usual financing proportions. The terms of any financing raised at the time of initiating a particular project do not represent the cost of capital for the firm. When a firm achieves its optimal capital structure, the weighted-average cost of capital is minimized

• Question 748:

  A company's beta value has decreased because of a change in its marketing strategy. Consequently, the discount rate applied to expected cash flows of potential projects will be

  A. Reduced.

  B. Increased.

  C. Unchanged.

  D. Zero.

  Correct Answer: A

  There is a positive relationship between a firm's beta value and the discount rate applied to cash flows. Thus, a decrease in beta value will reduce the discount rate.

• Question 749:

  Which of the changes in leverage would apply to a company that substantially increases its investment in fixed assets as a proportion of total assets and replaces some of its long- term debt with equity?

  

  A. Increase Decrease

  B. Decrease Increase

  C. Increase Increase

  D. Decrease Decrease

  Correct Answer: B

  Leverage is the amount of the fixed cost of capital, principally debt, in a firm's capital structure relative to its operating income It is also defined as the ratio of debt to total assets or debt to capital. Leverage, by definition, creates financial risk, which relates directly to the question of the cost of capital The more leverage, the higher the financial risk, and the higher the cost of debt capital. An increase in the equity component of the capital structure, however, decreases financial leverage Operating leverage is based on the degree that fixed costs are used in the production process. A company with a high percentage of fixed costs is riskier than a firm in the same industry that relies more on variable costs to produce. When fixed assets increase, operating leverage also increases

• Question 750:

  An analysis of a company's planned equity financing using the capital asset pricing model (or security market line) would incorporate only the

  A. Expected market earnings, the current U.S. Treasury bond yield, and the beta coefficient.

  B. Expected market earnings and the price-earnings ratio,

  C. Current U.S. Treasury bond yield, the price-earnings ratio, and the beta coefficient.

  D. Current U.S. Treasury bond yield and the dividend payout ratio.

  Correct Answer: A

  The capital asset pricing model adds the risk-tree rate to the product of the market risk premium and the beta coefficient. The market risk premium is the amount above the risk- free rate (approximated by the

  U.S. Treasury bond yield) that must be paid to induce investment in the market The beta coefficient of an individual stock is the correlation between the price volatility of the stock market as a whole and the price volatility of the individual stock.