CPE Self-study Examination

1. Which of the following is the most common maturity of U.S. Treasury- obligations selected by analysts to represent the risk-free rate?
a. 30 days
b. 5 years
c. 10 years
d. 20 years

2. Which of the following is NOT a maturity' of U.S. Treasury7 obligations for which Ibbotson publishes a corresponding equity risk premium series?
a. 30 days
b. 5 years
c. 10 years
d. 20 years

3. Which of the following terms are often (properly) used interchangeably1.
a. Cost, of capital, discount rate, and capitalization rate
b. Cost of capital and discount rate but not capitalization rate
c. Cost of capital and capitalization rate but not discount rate
d. Discount rate and capitalization rate but not cost of capital

4. The relevant yield on a debt instrument in calculating a company's cost of capital is:
a. Bi Slier the yield to maturity or the yield-to-call date but not the yield on the face value
b. Ritber the yield to maturity or the yield on the face value but not the yield-to-call date
c. Either the yield on the face value or the yield-to-call date but not the yield to maturity
d. The vield on the face value, the vield to maturity, or the vield-to-call date

5. Which of the following is a correct statement?
a. The capitalization rate is the reciprocal of the discount rate.
b- The capitalization rate is the reciprocal of the growth rate.
c. To get the capitalization rate, you subtract the long-term growth rate from the discount rate.
d. To get (lie capitalization rate, you add the long-term growth rate to the discount rate.

6. Which of the following must be subtracted from EBITDA to compute net cash flow to equity?
a. Interest (lax-affected), capital expenditures, and additions to working capital.
b. Depreciation, capital expenditures, and additions to working capital.
c. Capital expenditures and additions to working capital but neither interest nor depreciation.
d. Interest (tax-affected), capital expenditures, additions to working capital, and depreciation.

7. In the context of estimating the cost of capital, return on an investment generally is considered to have which of the following component or components?
a. Distributions (dividends or withdrawals)
b. Gain or loss in value whether realized or unrealized
c. Both (a) and (b) above
d. Neither (a) nor (b) above

8. The "risk-free rate" includes which of the following components?
a. A "real" rate of return and an inflation component.
b. A "real" rate of return and a component for interest rate risk
c. An inflation component and a component for interest rate risk
d. All of the above

9. When estimating a control value capital structure for a company writli $25 million revenue for the purpose of estimating a weighted average cost of capital (WACC), which of trie following is an appropriate source for the percentage of weight allocated to equity and the percentage of weight allocated to debt?
a. Risk Management Association's (formerly Robert Morris Associates) Annual Statement Studies
b. Financial Studies of the Small Business
c, Ibbotson Associates' Cost of Capital Yearbook
d. fcii (her (a) or (c) above would be appropriate

10. Cost of capita] is required in which of the following applications?
a. Business valuation
b. Project selection
c- Utility rate-setting
d. All of the above

11. Which of trie following is NOT an assumption of the Capital Asset Pricing Model (CAPM)?
a- Rational investors seek to hold efficient portfolios that is, portfolios that are fully diversified.
b. All investors have identical time horizons (i.e., expected holding periods).
c. All investors have identical expectations about such variables as expected rates of return and how capitalization rates are generated.
d. All of the above are assumptions of CAPM.

12. Which of the following is the primary source of takeover premiums for public companies?
a. Mergerstal Review
b. Mergerstat/Shannon Pratt's Control Premium StudyT
c. HLHZ Control Premium Study
d. Pratt's StatsT

13. Which of the following is the most accepted valuation method or approach by the Delaware Court of Chancery?
a. The market approach
b. The discounted cash flow method
c. The asset approach
d. The market approach and the discounted cash flow method have about equal acceptance.

14. When using the cost of capital to evaluate an investment in a project the cost of capital that should be used is the:
a. Company's WACC at the company's current capital structure
b. Company's WACC at the company's target capital structure
c. Project's WACC at the outset of the project
d- Project's WACC at the target capital structure over the life of the project

15. In the Stern Stewart & Co. version of EVA (economic value added), leveraged stock
options are: a. Bought, not granted; "in the money" rather than "out of the money"; and exercisable at a fixed price
b. Granted, not bought; "in the money" rather than "out of the money"; and exercisable at a price that increases based on the cost of capital.
c. Bought, not granted; "in the money" rather than "out of the money"; and exercisable at a price that increases based on the cost of capital.
d. Bought, not granted; "out of the money" rather than "in the money"; and exercisable at a price that increases based on the cost of capital.

16. Which, of the following are Ibbotson Associates publications?
a. Slocks, Bonds, Bills, and Inflation, Cost of Capital Yearbook, and COMPUSTAT
b. Stocks, Bonds, Bills, and Inflation, COMPUSTAT, and the Beta Book
c. Stocks, Bonds, Bills, and Inflation, Cost of Capital Yearbook, and the Beta Book
d. Cost of Capital Yearbook, COMPUSTAT, and the Beta Book

17. Which of the following models for estimating the cost of capital does NOT explicitly incorporate a "risk-free" rate?
a. Build-up model
b. Capital Asset Pricing Model (CAPM)
c. Discounted cash How (DCF) model
d. Arbitrage pricing theory (APT) model

For questions 18 and 19, the following are known about Company ABC:
Cost of debt on an after-tax basis: 6%
Cost of common equity capital: 20%
Debt at market val ue: 8500,000
Equity at market value: 8750,000
Debt at book val ue: 8500,000
Equity at book value: S500,000
Tax rate for ABC: 40%

18. The weighted average cost of capital for Company ABC equals:
a. 13.44%
b. 14.40%
c. 1 1.80%
d. 13.00%

19. The cost of debt before tax or the pretax cost of debt for Company ABC equals:
a. 2.4%
b. 3.6%
c. 10%
d. 15%

For questions 20 and 21, Hie following are known about private Company XYZ:
Estimated net cash flow to all invested capital for next 12 months: S350,000
Expected growth rate in perpetuity for net cash (low: 5.5%
Estimated weighted average cost of capital: 16%
The market value of debt: 81,500,000

20. The basic capitalization model yields which of the following values for Company X'overall capital ?
a. 83,333,333.33
b. 86,363,636.36
c. 82,187,500.00
d. $9,375,000.00

21. The estimated market value of equity for Company XYZ equals:
a. $4,863,636.36
b. $7,875,000.00
c. $687,500.00
d. $1,833,333.33

22. Beta is a measure of what type of risk?
a. Systematic
b. Unsystematic
c. Maturity
d. Financial

23. Which of the following is a multivariabie model that utilizes multiple regression analysis to estimate (lie cost of equity capital1?
a. Build-up model
b. Capital Asset Pricing Model (CAPM)
c. Discounted cash flow (DCF) model
d. Arbitrage pricing model

24. Which of the following is/are an accurate statexnent(s) about discounts for lack of marketability?
a. Both restricted stock studies and pre-IPO studies have resulted in consistent discounts for lack of marketability over the years.
b. Restricted slock studies showed lower discounts for lack of marketability since the SF.Cloosened reporting and trading restrictions in 1990.
c. Restricted stock studies have always indicated lower discounts than pre-TPO studies.
d. Bolti (b) and (c) are accurate statements.

25. If an acquiring company uses its own cost of capital to evaluate a potential acquisition, the result is:
a. Fair market value
b. Fair value

26. As risk goes up, the cost of capital goes down.

27. In the United States, the discount rate usually is stated in nominal terms.

28. The primary difference between the huild-up model and trie Capital Asset Pricing Model is the use of beta in fbeCAPM.

29. The cost of capital is equal to the discount rate.

30. The measure of net cash flow that should be discounted in the DCF model is (lie cash flow that is the weighted average (expected value) of trie probability distribution of possible outcomes.

31. Because the discount rate in the income approach is derived from public company stock trades, which are, by definition, minority interests, the result of a discounted cash flow valuation method is a minority interest value.
32. In ad valorem taxation, the statutory or regulatory measure of economic income to be discounted or capitalized is most likely net cash flow, or some variation of it.

33. Ibbotson Associates recommends that (lie beta-adjusted size premia data developed in its SBBI Valuation Edition be used only when the Capital Asset Pricing Model (CAPM) is being used.

34. Betas for private (closely held) companies are directly observable in the market.


35. There is empirical evidence to help quantify the size effect in terms of its impact on cost of equity capital.

36. Mergerstat/Skannon Pratt's Control Premium, StudyT is the primary source of control premiums paid in takeovers of public companies.


37. When evaluating a potential project, the company's overall cost of capital should be used to discount the project's expected cashflow to a present value.


38. The blended capitalization rate from tangible and intangible assets in me excess earnings method should approximately equal me capiliilization rate as developed by subtracting the growth rate from the discount rate using the build-up method or CAPM.


39. When estimating a company's weighted average cost of capital(WA('C), the components should be weighted by their respective book values.

40. Bankruptcy courts have not yet used cost of capital to value companies.