UNIVERSITY OF MINDANAO TAGUM COLLEGE

SECOND EXAMINATION
FINANCE 33
MARIA TERESA A. OZOA, CPA

TEST I: IDENTIFICATION
1. _______ is a model based on the proposition that any stocks required rate of return is equal to the risk free
rate plus a risk premium that reflects only the risk remaining after diversification. (CAPM)
2. _______ part of a securitys risk caused by factors unique to a particular firm. (DIVERSIFIABLE RISK)
3. _______ is a measure of the sensitivity of a securitys return relative to the returns of a broad based market
portfolio securities. (BETA)
4. _______ is the return required on a security having no systematic risk and is generally measured by the yield on
short term treasury securities. (RISK FREE RATE)
5. _______ represents the linear relationship between a securitys required rate of return and its risk as measured
by the beta. (SML)
6. _______ refers to the mix of debt, preferred stock and ordinary equity that the firm uses to finance the firms
assets. (capital structure)
7. _______ is the single most important determinant of capital structure and it represents the amount of risk that
inherent in the firms operations even it uses no debt financing. (business risk)
8. _______ is the additional risk placed on the ordinary equity shareholders as a result of the decision to finance
with debt. (financial risk)
9. _______ involves a choice between risk and expected returns associated with the firms financing mix. (capital
structure policy)
10. _______ measures the after tax return that the firm provides for all of its investors. (ROIC)

TEST II:
Instruction: Write TRUE if the statement is correct and FALSE if it is incorrect.
1. Diversifiable risk is the part of a securitys risk associated with random events that cannot be eliminated by
diversification.
2. A high-beta stock is less volatile than an average stock.
3. An average stock has b = 1.5.
4. The capital structure that balances risk and return to maximize the value of the firm is the optimal capital
structure.
5. EBIT EPS analysis is used to evaluate various capital structures in order to select that one that maximizes a
firms earnings per share.

TEST III:
Instruction: Write the letter that correspond to your answer.
1. Although debt financing is usually the cheapest component of capital, it cannot be used in excess because
A. interest rates may change.
B. the firm's stock price will increase and raise the cost of equity financing.
C. the financial risk of the firm may increase and thus drive up the cost of all sources of financing.
D. underwriting costs may change.
2. Within the capital asset pricing model
A. the risk-free rate is usually higher than the return in the market.
B. the higher the beta the lower the required rate of return.
C. beta measures the volatility of an individual stock relative to a stock market index.
D. two of the above are true.
3. The contemporary approach to capital structure management recognizes
a. Tax effects c. Agency costs
b. Bankruptcy costs d. All of the given choices
4. The traditional approach to capital structure management assumes
a. No taxes c. EBIT constant
b. All earnings are paid out as dividends d. All of the given choices
5. The Modigliani and Miller approach without corporate taxes suggest that the firms weighted average cost of
capital
a. Remains constant as the proportion of debt changes
b. Increases as the proportion of debt increases.
c. Decreases as the proportion of debt decreases.
d. Increases as the proportion of debt decreases.
TEST IV:

1. Oak Enterprises has a beta of 1.2, the market return is 11%, and the T-bill rate is 4%. What is their expected
required return of common equity?
A. between 11% and 12% C. between 12% and 13%
C. between 7% and 8% D. between 4% and 5%

ITEMS 2 - 3
The Push Investment Funds, in which you plan to invest some money has total capital of P 750,000,000 invested in six
stocks:

STOCK INVESTMENT STOCKS BETA COEFFICIENT

Z P 200 million 0.5
Y 160 million 2.0
X 125 million 2.0
W 125 million 1.0
V 100 million 1.0
U 40 million 1.25

2. What is the companys beta?

A. 0.65 C. 1.15
B. 1.06 D. 1.26
3. Assume that the risk-free rate is 6% and the market risk premium is 5%. What is the holding companys required
rate of return?
A. 9.25% C. 11.75%
B. 11.3% D. 12.3%

TEST IV:

Problem 1:
Gwyneth Corporation has expected earnings before interest and taxes(EBIT) of P 800,000 and interest costs of
P200,000. The firms equity and debt capitalization rates are 12.5% and 8%, respectively. Assume no corporate
income taxes.
1. What is the market value of the debt?
2. What is the market value of the equity?
3. What is the total market value of the firm?
4. What is the weighted average cost of capital?

Problem 2:
Suppose the risk free rate is 8%. The expected return on the market is 16%. If a particular stock has a beta of 0.7, what
is its excepted return based on the CAPM?