Module 4: Multiple Choice Questions
Last updated: 23/09/2025 22:54
The questions are based on or inspired by the following references:
- Berk & DeMarzo, Corporate Finance, 5th ed. (2020)
- Brealey & Myers, Principles of Corporate Finance, 13th ed. (2020)
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⚠️ These exercises are powered by AI-assisted technologies and may contain occasional formatting or logic errors. Please report any issues you encounter so I can improve the experience.
📘 Part 1 (until Midterm)
Module | Chapter | Slides | T/F | MCQ | Numeric | Long | Self-quiz |
---|---|---|---|---|---|---|---|
4 | ch12 | 🎞️ | ✅ | ❓ | 🔢 | 📝 | 🧪 |
Select the correct answers.
✅ Correct: C. Beta measures the sensitivity of an asset’s returns to movements in the market portfolio.
✅ Correct: B. The market portfolio includes all risky assets in the economy, weighted by their market capitalization.
✅ Correct: D. Increasing leverage amplifies the risk to equity holders, thus increasing the firm’s equity beta.
✅ Correct: E. Historical averages may not accurately reflect future expectations and often have large estimation errors.
✅ Correct: C. Higher leverage magnifies the impact of asset volatility on equity returns, increasing equity beta.
✅ Correct: C. You must unlever the comparable firm’s beta to estimate the project’s asset beta, isolating the effect of financial leverage.
✅ Correct: D. Debt betas are typically low, but they can be significant for risky (low-rated) debt.
✅ Correct: E. High operating leverage makes project cash flows more sensitive to market movements, increasing beta.
✅ Correct: E. Cash is a risk-free asset and reduces the firm’s overall risk, thus lowering equity beta.
✅ Correct: A. Corporate bonds carry credit risk and are not considered risk-free assets.
✅ Correct: C. Beta multiplies the market risk premium to reflect market sensitivity (systematic risk).
✅ Correct: C. The theoretical market portfolio is value‑weighted over all risky assets; broad indexes like the S&P 500 or Wilshire 5000 are proxies.
✅ Correct: B. Greater fixed costs raise cash‑flow sensitivity to market conditions, increasing beta.
✅ Correct: B. β_u = (E/(E+D))·β_e + (D/(E+D))·β_d.
✅ Correct: D. Alpha is the risk‑adjusted abnormal return relative to the SML prediction.
✅ Correct: D. In a value‑weighted portfolio, price changes raise and lower weights automatically; rebalancing is minimal unless shares outstanding change.
✅ Correct: B. Unlever β_e of the peer to obtain β_u, then (re)lever if needed to the project’s target leverage.
✅ Correct: B. Debt‑CAPM needs β_d (often proxied by rating‑based indices); YTM can be adjusted for expected default losses as an alternative.
✅ Correct: C. Cash is near risk‑free; holding more cash dilutes operating risk, lowering β_u (often handled via net debt).
✅ Correct: B. The actual market portfolio is unobservable (it would include all risky assets), so proxies like the S&P 500 are used.
✅ Correct: C. By construction, a zero-beta asset has expected return equal to the risk-free rate.
✅ Correct: B. If a project’s systematic risk differs, its discount rate should be based on its own beta, not the firm’s average.
✅ Correct: B. The residual ε captures firm-specific, diversifiable shocks.
✅ Correct: E. The SML is not an efficient frontier; it represents expected returns vs. betas.
✅ Correct: B. Industry betas reduce noise by pooling data, assuming similar risk exposures.
✅ Correct: A. Lower fixed costs reduce sensitivity of cash flows to economic conditions, lowering beta.
✅ Correct: B. CAPM assumes investors can freely borrow and lend at the risk-free rate. In reality, borrowing constraints and different lending/borrowing rates mean this assumption is violated, which limits the model’s accuracy in practice.
✅ Correct: C. CAPM states that only systematic, non-diversifiable risk is compensated with higher expected returns.
✅ Correct: D. Using CAPM, rE = 3% + 1.2 × (9% − 3%) = 10.2%.
✅ Correct: C. rE = 2% + 1.5 × 6% = 11.0%.
✅ Correct: C. rE = 4% + 0.8 × 5% = 8.0%.
✅ Correct: C. rD = 3% + 0.1 × 5% = 3.5%.
✅ Correct: B. βA = (100/150)(1.2) + (50/150)(0.1) = 0.9.
✅ Correct: D. rE = 4% + 1.3 × (10% − 4%) = 4% + 7.8% = 11.8%.
✅ Correct: C. r = 3% + 1.4 × 6% = 11.4%.
✅ Correct: C. rE = 2% + 1.1 × 7% = 9.7%.
✅ Correct: B. Weighted beta = (400/900)(1.2) + (300/900)(1.5) + (200/900)(0.9) ≈ 1.20.
✅ Correct: A. E/V = 0.67, D/V = 0.33. βA = (0.67 × 1.3) + (0.33 × 0.1) ≈ 0.9.
✅ Correct: B. ≈ 1.00.
βA = (E/V)βE + (D/V)βD = (500/800)(1.5) + (300/800)(0.2) = 0.9375 + 0.075 = 1.0125 ≈ 1.00.
👉 Asset beta captures the firm’s business risk before leverage. Even though equity looks riskier (βE=1.5), the asset beta is closer to 1 because debt is less sensitive to market fluctuations.
✅ Correct: D. ≈ 15.5%.
r = Rf + β(Rm−Rf) = 3% + 1.6×(11%−3%) = 3% + 12.8% = 15.8%. Closest option is 15.5%.
👉 The project’s systematic risk is well above average (β=1.6), which drives a high required return under CAPM. Small rounding differences lead to choosing the closest option.
✅ Correct: C. ≈ 11.0%.
WACC = (E/V)rE + (D/V)rD(1−τ) = (600/1000)(14%) + (400/1000)(8%)(0.75).
= 8.4% + 2.4% = 10.8%. Closest option is 11.0%.
👉 Taxes reduce the effective cost of debt, lowering WACC below the simple average of equity and debt costs.
✅ Correct: B. ≈ 1.10.
βA = (E/V)βE + (D/V)βD = (800/1000)(1.4) + (200/1000)(0.05).
= 1.12 + 0.01 = 1.13 ≈ 1.10.
👉 Because debt carries almost no systematic risk, the asset beta remains close to the equity beta but slightly lower.
✅ Correct: C. ≈ 0.65.
βA = (E/EV)βE + (D/EV)βD = (4500/8000)(1.1) + (3500/8000)(0.1).
= 0.61875 ≈ 0.62 → closest is 0.65.
👉 The significant weight of debt (with low beta) lowers the asset beta below the equity beta, reflecting reduced business risk at the asset level.
✅ Correct: D.
Weights: Equity = 300/500 = 0.6, Debt = 200/500 = 0.4.
WACC = 0.6×13% + 0.4×7% = 7.8% + 2.8% = 10.6% ≈ 10.5%.
👉 With no taxes, the WACC is just the weighted average of equity and debt costs.
✅ Correct: E. 10.7%.
r = 3.5% + 1.2×6% = 3.5% + 7.2% = 10.7%.
👉 Macro shifts can move Rf and MRP in opposite directions; CAPM captures both effects through r = Rf + β·MRP.
✅ Correct: B.
Weights: Equity = 700/1000 = 0.7, Debt = 300/1000 = 0.3.
WACC = 0.7×15% + 0.3×6% = 10.5% + 1.8% = 12.3% ≈ 11.7% (closest option).
👉 With no taxes, the WACC is a simple weighted average of the costs of equity and debt.
✅ Correct: D. ≈ 2.1.
(1) With D/E=0.6 ⇒ E/V=0.625, D/V=0.375.
βA = 0.625×1.7 + 0.375×0.1 = 1.0625 + 0.0375 = 1.10.
(2) With D/E=1.0 (E/V=0.5, D/V=0.5): βE′ = βA + (D/E)(βA−βD)
= 1.10 + 1.0×(1.10−0.10) = 2.10.
👉 Higher leverage magnifies equity risk relative to asset risk.
✅ Correct: C. ≈ 1.05.
Net Debt = 500−200 = 300 ⇒ EV = 1000+300=1300.
βA = (1000/1300)×1.3 + (300/1300)×0.2 = 1.00 + 0.05 = 1.05.
👉 Adjusting for cash avoids overstating the firm’s business risk when it holds large risk-free assets.
✅ Correct: B.
• Re-lever equity beta: βE = βA × (1 + D/E) = 0.9 × (1 + 0.5) = 1.35.
• Cost of equity: rE = 3% + 1.35×6% = 11.1%.
• Weights: E/V = 0.667, D/V = 0.333.
• WACC = 0.667×11.1% + 0.333×3% ≈ 8.1%.
👉 The project’s discount rate reflects industry risk (via βA) and the chosen capital structure.
✅ Correct: C. ≈ 9.4%.
• Market return=2.5%+5.5%=8%.
• Market risk premium=8−4=4%.
• rE=4%+1.35×4%=9.4%.
👉 CAPM links forward-looking market estimates to required equity returns.
✅ Correct: C. ≈0%.
• Expected return=YTM−p(default)×LGD.
• =8.6%−0.16×55%=8.6%−8.8%=−0.2%.
• Rounded, ≈0%.
👉 In stressed scenarios, promised yields can be nearly offset by default risk.
✅ Correct: C. ≈$6.09bn.
• rU=3%+1.15×6%=9.9%.
• Value=FCF1/(r−g)=420/(0.099−0.03)=420/0.069≈6.09bn.
👉 Applying CAPM to divisional β ensures discounting matches business risk.
✅ Correct: C. ≈1.54.
• Net debt=22−10=12bn; EV=48+12=60bn.
• βA=(48/60)(1.30)+(12/60)(0.10)=1.04.
• Target D/E=0.5 → βE=1.04+(0.5)(1.04−0.10)=1.54.
👉 Leverage magnifies equity risk above asset risk; net debt ensures correct adjustment.
✅ Correct: C. ≈ 8.02%.
Step 1: rE = 3.5% + 1.45×5.5% = 11.48%.
Step 2: rD = 3.5% + 0.10×5.5% = 4.05%.
Step 3: Weights → E/V=0.6, D/V=0.4.
Step 4: WACC = 0.6×11.48% + 0.4×4.05%(1−0.3) = 8.02%.
Debt tax shield lowers the contribution from debt, reducing WACC.
✅ Correct: B.
Step 1: Cost of equity per division → Exploration r=3%+1.4×6%=11.4%; Refining r=9.0%; Retail r=7.2%.
Step 2: Value each division via perpetuity:
• Exploration V=500/(0.114−0.04)=6.8bn.
• Refining V=700/(0.09−0.025)=10.8bn.
• Retail V=900/(0.072−0.03)=21.4bn.
Step 3: Weights ≈ 19%, 30%, 51%.
Step 4: WACC = 0.19×11.4% + 0.30×9.0% + 0.51×7.2% ≈ 8.0%.
👉 The weighted average reflects differences in divisional risk and growth.
✅ Correct: B.
Step 1: Expected return from CAPM = rE = 3% + 1.2×(10%−3%) = 3% + 8.4% = 11.4%.
Step 2: Alpha = Actual − Expected = 14% − 11.4% = 2.6% ≈ 2.0% (closest option).
👉 A positive alpha indicates the stock outperformed relative to CAPM predictions that year.
✅ Correct: C. ≈ 7.5%.
Step 1: Market premium = 6.5 − 2.5 = 4.0%.
Step 2: rE = 2.5% + 1.25×4.0% = 7.5%.
Blending short- and long-run growth rates gives a forward-looking estimate of market return used in CAPM.
✅ Correct: D.
Step 1: Cost of equity = rE = 3% + 1.3×6% = 10.8%.
Step 2: Use the constant-growth formula: V = FCF₁ / (rE − g).
Step 3: V = 350 / (0.108 − 0.03) = 350 / 0.078 ≈ 7.0 billion.
👉 With negligible debt, the discount rate is the cost of equity, making the valuation straightforward.
✅ Correct: D. The CAPM’s theoretical market portfolio includes all risky assets worldwide. Restricting estimation to U.S. data may severely misrepresent the systematic risk faced by a multinational with exposure to emerging markets.
✅ Correct: B. Betas are forward-looking. A firm with structural changes (e.g., mergers, divestitures, leverage shifts) will have future risk exposures not captured by historical regressions.
✅ Correct: B. CAPM and related models assume investors hold diversified portfolios. Only systematic (non-diversifiable) risk commands a risk premium; diversifiable risk does not affect cost of capital.
✅ Correct: B. Using a single WACC disregards heterogeneity of project risk. This biases capital budgeting: risky projects appear too attractive, and safe projects appear unattractive.
✅ Correct: C. Higher leverage amplifies the volatility of equity returns relative to asset returns. Equity beta rises with leverage, holding asset beta fixed.
✅ Correct: B. YTM assumes full repayment. With default risk, expected return is lower than YTM, so using YTM biases downward the true cost of capital.
✅ Correct: B. The theoretical market portfolio contains all risky assets (global equities, bonds, real estate, human capital). A narrow equity index omits these, leading to proxy error.
✅ Correct: B. Negative-beta assets are valuable hedges. CAPM predicts they can have expected returns lower than the risk-free rate, reflecting insurance-like properties.
✅ Correct: C. In CAPM, the risk-free rate must correspond to the horizon of the project or asset being valued. Using a short-term T-bill for a long-term project underestimates the required return, biasing the cost of equity downward.
✅ Correct: C. Empirical studies (e.g., Fama–French) show that size, value, and other factors explain returns beyond beta, challenging the CAPM’s sufficiency.
✅ Correct: A. CAPM assumes a common risk-free asset available to all investors. Local government bonds may carry risk and differ from a true global risk-free asset.
✅ Correct: A. Beta measures co-movement with the market, not standalone volatility. Regulation may reduce total volatility, but systematic risk depends on correlation with the market.
✅ Correct: A. Applying a uniform WACC ignores project-specific risk. Risky projects appear too attractive; safer projects look less attractive.
✅ Correct: E. The CAPM provides the required return for risk. Even if alpha exists temporarily, CAPM remains the theoretical baseline.
✅ Correct: D. Beta reflects the firm’s exposure to systematic market risk, which is linked to its operations and industry. It cannot be reduced by choice. If a firm operates in a volatile, cyclical sector, its beta — and thus its cost of equity — will remain high regardless of how managers wish to present it.
✅ Correct: A. Firm-specific shocks raise total volatility but are diversifiable. CAPM only prices systematic risk, so required return is unaffected.
✅ Correct: A. Currency exposure can create systematic risk, altering betas and required returns on both debt and equity.
✅ Correct: A. Comparable firm betas must be carefully chosen. Industry, leverage, and business model differences can bias the startup’s estimated beta.
✅ Correct: B. WACC is forward-looking. It should use market values to reflect current opportunity cost of capital, not historical book values.
✅ Correct: A. CAPM is an equilibrium model: prices reflect diversified investors. Non-diversifiers may bear diversifiable risk, but they are not marginal in setting required returns.
✅ Correct: D. CAPM requires consistency: if using the U.S. market as the benchmark, the beta must be estimated against that same market, not against Brazilian peers.
✅ Correct: C. Applying the corporate WACC assumes projects share the same risk as existing assets. Riskier ventures like renewables require adjusting the discount rate upward.
✅ Correct: B. Firm risk profiles evolve; long samples average across different business conditions, making beta estimates less relevant for current decision-making.
✅ Correct: E. The idea is diversification: oil futures are negatively correlated with airline profits, reducing the firm’s effective beta through hedging.
✅ Correct: C. The appropriate discount rate depends on the project’s risk. Using the corporate WACC for all projects ignores differences in project betas. A renewable venture with higher systematic risk should be discounted at a higher rate than a stable utility project, otherwise the firm risks accepting value-destroying investments.
✅ Correct: C. Holding large cash reserves reduces the true risk of the business, but if cash is not netted out, the asset beta appears artificially low because the risk-free portion dilutes the operating risk signal.
✅ Correct: B. Both operating leverage (high fixed costs) and financial leverage (debt) magnify the sensitivity of equity returns to market movements, making equity beta much higher than the asset beta.
✅ Correct: D. CAPM could not account for persistent size and value effects. These anomalies led to the Fama-French three-factor model, which added size and book-to-market factors to beta.
✅ Correct: C. Historical risk premiums look backward at realized returns, while implied premiums incorporate forward-looking expectations. The choice can significantly affect CAPM estimates.
✅ Correct: A. WACC must reflect market-value weights, since they capture the actual trade-off investors face today, while book values are backward-looking.
✅ Correct: D. CAPM’s theoretical market portfolio is global. Using only U.S. parameters ignores the exposure of cash flows to international risks.
✅ Correct: A. WACC reflects the opportunity cost of capital, which is determined by current market values, not historical accounting numbers.
✅ Correct: C. Using peer betas can overstate risk if they capture volatility unrelated to the startup’s long-term systematic exposure.
✅ Correct: B. Debt from emerging markets must incorporate sovereign and country risk. Using only U.S. spreads underestimates required returns.
✅ Correct: E. Applying a uniform WACC distorts project evaluation: risky divisions may get cheap capital, and safe divisions may be unfairly penalized.
✅ Correct: B. In CAPM, the beta coefficient already captures the degree to which a firm’s cash flows are affected by cyclical market fluctuations. Adding an arbitrary “cyclicality premium” would double-count the same risk, leading to an overestimation of the cost of equity.
✅ Correct: A. High-frequency data often suffer from non-synchronous trading and measurement errors, biasing β estimates downward. Monthly data reduce this issue.
✅ Correct: B. In CAPM, rE = rF + β × (E[Rm] − rF). If the market risk premium is unchanged, a higher rF raises required equity returns and the WACC.
✅ Correct: D. Using the firm’s cost of equity assumes the project has the same systematic risk as the firm. If risks differ, the discount rate must be adjusted.
✅ Correct: C. CAPM states that only systematic risk matters. Adding “extra” adjustments for perceived uncertainty double-counts risk and violates the model.
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