Module 4: Multiple Choice Questions

For students

Last updated: 17/08/2025 11:05

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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💡 You can also press Ctrl + P (or Cmd + P on Mac) to print or save your responses as a .pdf file.

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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.

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📘 Part 1 (until Midterm)

Module	Chapter	Slides	T/F	MCQ	Numeric	Long
4	ch12	🎞️	✅	❓	🔢	📝

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Answer the following questions based on the discussions in class.

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Q1.

In the CAPM formula, which component captures the asset’s sensitivity to market movements?

A. Risk-free rate
B. Market risk premium
C. Beta
D. Standard deviation
E. Alpha

✅ Correct: C. Beta measures the sensitivity of an asset’s returns to movements in the market portfolio.

Q2.

Which of the following best describes the market portfolio in theory?

A. An equal-weighted portfolio of all stocks in the Ibov index
B. A value-weighted portfolio of all available risky assets
C. A portfolio that holds only government bonds
D. A price-weighted index like the DJIA
E. A portfolio that minimizes volatility

✅ Correct: B. The market portfolio includes all risky assets in the economy, weighted by their market capitalization.

Q3.

Which of the following increases a firm’s equity beta?

A. Increasing cash holdings
B. Reducing fixed costs
C. Decreasing financial leverage
D. Increasing financial leverage
E. Increasing dividend payments

✅ Correct: D. Increasing leverage amplifies the risk to equity holders, thus increasing the firm’s equity beta.

Q4.

Which of the following is a drawback of using historical averages to estimate the market risk premium?

A. They do not consider dividends
B. They ignore risk-free rates
C. They are based on forward-looking estimates
D. They cannot be used for long-term projects
E. They often come with large standard errors and are backward-looking

✅ Correct: E. Historical averages may not accurately reflect future expectations and often have large estimation errors.

Q5.

Which of the following is the primary reason why increasing leverage amplifies a firm’s equity beta?

A. Because debt increases the firm’s total assets
B. Because bondholders demand higher returns as leverage increases
C. Because equity holders face greater variability in returns as debt obligations increase
D. Because higher leverage decreases the market risk premium
E. Because leverage increases firm-specific risk, which is fully priced by the market

✅ Correct: C. Higher leverage magnifies the impact of asset volatility on equity returns, increasing equity beta.

Q6.

When estimating a project’s cost of capital using comparable firms, which of the following adjustments is essential if the firm has significant leverage?

A. Adjusting the firm’s dividend payout ratio
B. Adjusting the firm’s tax rate
C. Unlevering the comparable firm’s beta
D. Using the comparable firm’s historical average return
E. Applying the comparable firm’s WACC directly

✅ Correct: C. You must unlever the comparable firm’s beta to estimate the project’s asset beta, isolating the effect of financial leverage.

Q7.

Which of the following statements about debt betas is correct?

A. Debt betas are always equal to zero
B. Debt betas are higher than equity betas for most firms
C. Debt betas are irrelevant when estimating the firm’s WACC
D. Debt betas are generally low, but not necessarily zero, especially for lower-rated bonds
E. Debt betas are always negative due to their inverse relation to market returns

✅ Correct: D. Debt betas are typically low, but they can be significant for risky (low-rated) debt.

Q8.

Which of the following factors increases a project’s beta?

A. High correlation with firm-specific risk
B. Low financial leverage
C. Low fixed costs and high variable costs
D. Increase in cash reserves
E. High operating leverage (fixed costs relative to variable costs)

✅ Correct: E. High operating leverage makes project cash flows more sensitive to market movements, increasing beta.

Q9.

Which of the following actions would typically decrease a firm’s equity beta, holding all else constant?

A. Increasing the firm’s dividend payout
B. Raising additional debt financing
C. Increasing the firm’s operating leverage
D. Taking on projects with higher correlation to market returns
E. Increasing cash holdings relative to total assets

✅ Correct: E. Cash is a risk-free asset and reduces the firm’s overall risk, thus lowering equity beta.

Q10.

Which of the following would NOT be considered a valid proxy for the risk-free rate in the CAPM model?

A. A corporate bond rated BBB
B. A 10-year Government bond
C. A 3-month Government bill
D. A 20-year fixed-rate Government bond
E. A Selic overnight rate

✅ Correct: A. Corporate bonds carry credit risk and are not considered risk-free assets.