11/17/24, 3:39 PM Yawen Zhang - 2024-10 - Core 2 - Ontario - Chartered Professional Accountants of Canada

Unit 4 Quiz - Results

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Written Nov 3, 2024 12:31 PM - Nov 3, 2024 5:11 PM

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Question 1

The current risk-free rate is 2.1% and the market risk premium is 5%.
XYC Co.’s common equity has a beta of 1.5.

Which one of the following is the expected cost of equity for XYC?

a) 6.45%

b) 8.15%

c) 9.6%

d) 10.65%

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Option c) is correct. The expected cost of equity is calculated as 2.1%

+ 1.5(5%) = 9.6%.

Question 2

Karry’s Care Ltd. has a current yield on debt of 7% and a current cost
of equity of 10%. The weighting of debt in the company’s current
capital structure is 35%. The company’s income tax rate is 22%.

Which one of the following is the weighted average cost of capital

(WACC) for Karry’s Care?

a) 7%

b) 7.5%

c) 8.4%

d) 8.9%

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Option c) is correct. 35%(7%)(1 – 0.22) + 65% (10%) = 1.9% + 6.5% =

8.4%.

Question 3

The shares of Sunshine Ltd. are currently trading at $54.65 per share
and have a beta of 1.5. The risk-free rate of return is 2.0% and the
average market risk premium is 4.5%.

Which one of the following is the required rate of return on Sunshine’s

shares?

a) 5.75%

b) 6.75%

c) 8.75%

d) 11.75%

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Option c) is correct. The cost of equity is calculated as follows: CAPM

= Rf + β (Rm – Rf) = 2.0% + 1.5(4.5%) = 8.75%.

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Question 4

A company has outstanding debt with a current market value of

$1,058, a face value of $1,000, and an annual coupon rate of 6%, paid
semi-annually. The bond has seven years to maturity.

Which one of the following is the bond’s current cost of debt, before
tax?

a) 2.5%

b) 4.2%

c) 5.0%

d) 10.8%

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Option c) is correct. PV = –$1,058; FV = $1,000; PMT = $30 (1,000 ×

6% / 2); N = 14 (2 × 7); CPT I/Y = 2.5%; cost of debt is 2 × 2.5% = 5%.

Question 5

SCC Inc. has the following financial information reported at current

market values:

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Current $900,000
liabilities

Long-term debt $1,300,000

Total liabilities $2,200,000

Preferred $3,500,000
shares

Common equity $6,200,000

The long-term debt consists of a single bond issue paying 6% interest

annually. These bonds currently yield 7.5% in the market. The current
cost of the preferred shares is 8%. The current cost of the common
shares is 12%. The company’s tax rate is 20%.

Which one of the following is SCC’s weighted average cost of capital

(WACC), rounded to the nearest 10th of a percent?

a) 9.2%

b) 9.7%

c) 10.0%

d) 10.2%

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Option c) is correct. The calculation is as follows:

WACC = [(1.3 / 11) × 7.5%(1 – 0.20)] + [(3.5 / 11) × 8%] + [(6.2 / 11) ×
12%]
= 0.709% + 2.545% + 6.764% = 10.0%
Note: Total long-term debt and equity = $1,300,000 + $3,500,000 +
$6,200,000 = $11,000,000

Question 6

YSJ Inc. has the following market values for its liabilities and equity:

Current $1,500,000
liabilities

Total liabilities $8,500,000

Preferred $3,000,000
shares

Common $10,000,000
equity

The long-term liabilities consist of a single bond issue paying 5%

interest annually. The annual yield for similar bonds in the market is
currently 8%. The current cost of the preferred shares is 6% and the
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current cost of the common shares is 17%. The company’s tax rate is
37%.

Which one of the following is YSJ’s weighted average cost of capital

(WACC), rounded to the nearest 10th of a percent?

a) 10.5%

b) 10.7%

c) 11.2%

d) 12.2%

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Option c) is correct. The correct calculation is as follows:

After-tax cost of debt = 8% × (1 – 0.37) = 5%; cost of preferred shares
= 6%; cost of common shares = 17%
Total long-term debt (total liability – current liability) + equity =
$7,000,000 + $3,000,000 + $10,000,000 = $20,000,000
WACC = [(7 / 20) × 5%] + [(3 / 20) × 6%] + [(10 / 20) × 17%] = 1.75%
+ 0.90% + 8.5% = 11.15%, rounded to 11.2%

Question 7

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A company’s managers are assessing an investment that currently has

a positive net present value (NPV) of $25,000 using a discount rate of
12%. A time period of four years has been used.

Which one of the following statements is true?

a) A reduction in the amount of forecasted cash inflows will

increase the NPV.

b) If the initial investment at Time 0 increases, this will increase

the NPV.

If the investment generated a cash inflow in Year 5 and this was

c)
included in the NPV calculation, the NPV would be lower due
to discounting.

d) If the discount rate is changed to 14%, this will cause the NPV
to be lower than $25,000.

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Option d) is correct. A higher discount rate always reduces the NPV.

Question 8

Costmo Inc. is using the present value interest factor (PVIF) formula
approach to determine the net present value (NPV) of an investment.
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If a discount rate of 12% is being used, which one of the following will
be the PVIF for cash flows received in Year 4?

a) 0.2232

b) 0.5997

c) 0.6355

d) 1.5735

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Option c) is correct. It is calculated as follows: 1 / (1.12)4.

Question 9

Boros Ltd. has determined the net cash flows to be generated from a
project as follows:

Year 1 $50,000

Year 2 $75,000

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Year 3 $30,000

The appropriate discount rate for this investment is 15%.

Which one of the following represents the amount Boros must initially
invest in this project to generate a return of 15%?

a) $119,915

b) $134,783

c) $137,902

d) $155,000

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Option a) is correct. The present value is calculated using the formula

NPV (15%, 50,000, 75,000, 30,000). The amount of the initial
investment to generate a project return of 15% will be equal to the
present value of all the cash flows, giving an NPV of 0.

Question 10

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A company’s managers are considering an investment in a project that

is expected to generate the cash flows shown below.

Year 0 $(2,000)

Year 1 $(100)

Year 2 $900

Year 3 $1,500

The required rate of return on the project is 7%

Which one of the following is the net present value (NPV) for this
investment?

a) –$83

b) –$77

c) $103

d) $150

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Option a) is correct. The present value is calculated using the formula

NPV (7%, –100, 900, 1,500) + –2,000. Note that the Year 0 cash flow
(–2,000) is not included in the NPV formula because it occurs in Year 0
and thus should not be discounted. Therefore, the NPV is calculated
without Year 0 and then added to –$2,000.

Question 11

Howard Co. is considering a project that will initially cost $450,000.

The net cash flows for the first three years are as follows:

Year 1 $100,000

Year 2 $60,000

Year 3 $290,000

The appropriate discount rate is 8%. The net present value (NPV) of
the first three years of cash flows is –$75,756.

Which one of the following is the cash flow for Year 4 in order to give
a total NPV of $50,008 for the project?

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a) $68,035

b) $92,437

c) $103,069

d) $171,107

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Option d) is correct. The PVIF for Year 4 is calculated as 1 / (1.08)4 =

0.7350. Therefore, the cash flow for Year 4 must be ($75,756 +
$50,008) / 0.735 = $171,107.

Question 12

Theoretically, a company’s optimal capital structure should be based

on which one of the following principles?

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a) Debt should be used to the point where the weighted average

cost of capital (WACC) is minimized.

b) Debt should be used to the point where the cost of debt is

minimized.

c) Equity financing should be maximized to eliminate the risk of

borrower default.

d) Equity and debt financing should be balanced so that the beta

of equity is equal to 1.

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Option a) is correct. The point at which WACC is minimized is the

point at which the mix of debt and equity results in the lowest overall
financing cost. As such, it corresponds to the point where firm value is
maximized and thus debt financing at this point is optimal.

Question 13

Which one of the following companies is MOST likely able to use debt
financing to improve shareholder returns, provided that investments
are profitable?

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a) A company that has financially strong competitors with low

debt balances

b) A company with a steady, predictable cash flow

c) A company with low earnings and cumulative losses

d) A company with high costs of financial distress

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Option b) is correct. A company with a steady, predictable cash flow

will be considered low risk, and therefore could benefit from financing
with a low after-tax cost of debt. A source of low-cost financing
coupled with profitable, potential investment alternatives can result in
increased shareholder returns.

Question 14

Which one of the following businesses likely has the HIGHEST degree
of operating leverage?

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A residential apartment business that recently paid off its

a)
mortgages

A hotel that recently purchased the adjoining land using debt

b)
financing

c) A home-based manufacturing business making clothing

d) A retail clothing store business

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Option b) is correct. A hotel that recently obtained debt financing

would have a higher percentage of fixed costs due to the principal and
interest on the debt relative to variable costs, resulting in higher
operating leverage.

Question 15

Joshmane Inc. is assessing the impact on its cost of equity if the

proportionate amount of debt in its capital structure is increased to
40% from the current 15%.

With this change, which one of the following will be the impact on the
company’s cost of equity?
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a) The cost of equity will decline due to lower operating risk.

b) The cost of equity increases due to more financial risk.

c) The cost of equity will remain unchanged.

d) The cost of equity will decrease due to lower financial risk.

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Option b) is correct. Financial risk increases as the proportion of debt

is increased, and therefore the overall cost of equity will increase.

Question 16

Laurie wants to have $50,000 in 10 years for a vacation. She is

considering an investment that will pay annual interest of 6%,
compounded quarterly.

How much does Laurie need to invest today in this investment?

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a) $27,563

b) $27,920

c) $43,083

d) $90,701

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Option a) is correct. The inputs are FV = –50,000; N = 10 × 4 = 40; I/Y

= 6% / 4 = 1.5; and CPT PV = $27,563.

Question 17

The bank is offering a savings account that will earn interest at 4%,
compounded quarterly. The inflation rate is 1%.

Which one of the following is the effective annual rate (EAR) for this
account, rounded to the nearest 10th of a percentage?

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a) 3.0%

b) 4.0%

c) 4.1%

d) 17.0%

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Option c) is correct. The EAR = (1 + 0.04 / 4)4 – 1 = 0.0406 = 4.06%.

Question 18

Suzanne wants to save for her son’s education and needs to have
$140,000 in seven years. She currently has $10,000 that can be
immediately deposited in a savings investment. The investment has an
annual interest rate of 6%, compounded monthly.

How much must Suzanne deposit at the beginning of each month in

this investment to have the required amount when it matures?

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a) $511

b) $1,193

c) $1,199

d) $1,339

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Option c) is incorrect. The payment is made at the beginning of the

month, not at the end of the month. Option b) is correct. The payment
is made at the beginning of the month. The inputs are PV = 10,000; N
= 7 × 12 = 84; I/Y = 6% / 12 = 0.5%; FV = –140,000; and CPT PMT =
$1,193.

Question 19

Freedom Co. is examining an investment that will pay $1,000 semi-

annually (at the end of each period) for 15 years. At the end of 15
years, the investment will also pay a lump sum of $75,000. The present
value of these cash flows is $67,754.42.

Which one of the following is the stated annual rate for this
investment?

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a) 0.68%

b) 1.75%

c) 3.5%

d) 4.18%

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Option c) is correct. The inputs for this calculation are: PV = –

67,754.42; N = 15 × 2 = 30; PMT = 1,000; FV = 75,000; CPT I/Y =
1.75%. The stated annual rate is 1.75% × 2 = 3.5%.

Question 20

Which one of the following activities is the BEST example of a non-

value-added activity?

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a) Adding security protection to packaging of a high-value

product

b) Customizing a training manual for a client

c) A software developer providing regular updates to the software

program

d) Producing extra products to have on hand

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Option d) is correct. The most important characteristic of a non-value-

added activity is that it adds costs to the production process without
adding value. Over-producing does not add value to the production
process.

Question 21

Strategic cost management asserts that costing systems should be

focused on identifying opportunities to reduce costs and helping the
organization to achieve its strategic objectives.
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Which one of the following is an important implication of these

principles?

a) Strategic cost management should not be adopted by not-for-

profit organizations.

b) There is more than one costing system that can be appropriate

for various organizations.

c) The cost of strategic planning should be kept to a minimum.

d) Every organization should implement activity-based costing.

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Option b) is correct. Strategic cost management is a process that first

seeks to identify the cost relationships among the activities in the
value chain and then endeavours to manage those cost relationships
to the firm's advantage. Such a process would identify and analyze
cost drivers with the objective of lowering costs and maximizing total
value. As no two organizations would necessarily share the same cost
drivers, no single costing system is suitable for all organizations.

Question 22

Rasmussen Video Systems (RVS) has sales of $8.9 million in the year
and has the following quality costs (in $’000s):

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Quality cost Item Amount

category

Internal failure Scrap 160

Internal failure Rework costs 150

Appraisal Incoming materials 20

inspection

Prevention Training 15

External failure Warranty repair 200

Prevention Supplier evaluations 45

Appraisal Line inspection 85

External failure Customer support 60

Internal failure Breakdown maintenance 50

Appraisal Product testing 40

RVS is considering changes to the manufacturing process that will cost

$1,500,000 but will reduce the amount of scrap and rework by 35%.
Furthermore, line inspection costs can be reduced by 15%.

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If the changes proceed and the $1,500,000 investment is made, which

one of the following is the new appraisal cost as a percentage of sales?

a) 1.49%

b) 1.63%

c) 1.65%

d) 2.33%

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Option a) is correct. Appraisal costs: [$20 + ($85 × 0.85) + $40] /

$8,900 = 1.49%.

Question 23

A manufacturer has the following data:

Hours required per unit

Available annual
Department machine hours Widget A Widget B

Assembly 10,000 3 4

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Packaging 4,000 1 2

The contribution margin (CM) per unit for Widget A is $12 and for
Widget B is $14. Current market demand for Widget A is limited to
2,500 units per year.

Which one of the following is the yearly product mix that maximizes
profitability?

a) 0 Widget A, 2,000 Widget B

b) 2,000 Widget A, 1,000 Widget B

c) 2,500 Widget A, 625 Widget B

d) 0 Widget A, 2,500 Widget B

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Answer c) is correct. Confirm using trial and error:

A B CM
0 2,000 $28,000
2,500 625 $38,750

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Therefore, the optimal product mix is the maximum number of Widget

A (2,500) and using the remaining available machine hours to produce
625 units of Widget B.

Question 24

Deatter Co. is a manufacturer of office furniture. It sells two products:

X and Y. Cost information is listed below:

Product XProduct Y

Selling price $490 $560

Variable costs 280 420

Contribution $210 $140

Machine hours to produce one unit 0.8 0.4

Maximum unit sales per month 525 700

The company presently operates the machine for a single eight-hour

shift for 23 working days each month. Management is thinking about
operating the machine for two shifts, which will increase the machine’s
availability by another eight hours per day for 23 days per month. This
change would require additional fixed costs of $5,000 per month.

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If the company decides to set up the new shift, which one of the
following is the objective formula for the month?

a) 262.5X + 350Y – 5,000 = profit

b) 0.8X + 0.4Y ≤ 8 hours

c) 0.8X + 0.4Y ≤ 368 hours

d) 210X + 140Y – 5,000 = profit

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Option d) is correct. The objective formula focuses on profit

maximization. The constraints are not part of this equation, as it is
strictly focused on CM per unit, per product, less monthly fixed costs.

Question 25

Growit, a seed packing and distribution company, has just completed

its first year of operations and has started to compile its three-year
operational budget. Growit is using regression analysis in its business
planning and has come up with four scenarios.

Which of the following represents the strongest relationship between

the two variables, based on the regression analysis summary output?

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a) Biweekly maintenance costs and machine hours

b) Monthly labour hours and overhead costs

c) Monthly number of units produced and distribution costs

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d) Monthly number of shipments and logistics costs

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Answer c) is correct. The r2 shows a clear relationship between the

two variables with 84% of the points falling close to the linear line, but
the standard error is high, which is a cause for concern. The P-value
for the number of units t stat is < 0.05, suggesting a significant cause-
and-effect relationship, and the upper and lower 95% values are both
positive. While this data set is the strongest provided, with a sample
size of 12, the results could be misleading, so it is recommended that
Growit expand its data set as the company obtains more information.

Done

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