AICPA CPA-Business Exam - Topic 2 Question 95 Discussion

Actual exam question for AICPA's CPA-Business exam

Question #: 95
Topic #: 2

DQZ Telecom is considering a project for the coming year, which will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment.

* Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8 percent, and flotation costs of 2 percent of par.

* Use $35 million of funds generated from earnings.

The equity market is expected to earn 12 percent. U.S. treasury bonds are currently yielding 5 percent.

The beta coefficient for DQZ is estimated to be .60. DQZ is subject to an effective corporate income tax rate of 40 percent.

The Capital Asset Pricing Model (CAPM) computes the expected return on a security by adding the riskfree rate of return to the incremental yield of the expected market return, which is adjusted by the company's beta. Compute DQZ's expected rate of return.

A9.20 percent.

B12.20 percent.

C7.20 percent.

D10.00 percent.

Show Suggested Answer

Suggested Answer: A

Choice 'a' is correct. Average collection period has decreased due to a change in credit policy that has caused:

1. Increase in sales,

2. Increase in discounts taken,

3. Decrease in the amount of bad debt; and

4. Decrease in the investment in accounts receivable

Choice 'b' is incorrect. Percentage discount offered has probably increased, as discounts taken has increased.

Choice 'c' is incorrect. Accounts receivable turnover has increased, as sales are up and accounts receivable are down.

Choice 'd' is incorrect. Change in gross profit and working capital is not determinable from these facts.

by Magnolia at Aug 24, 2024, 08:07 AM

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Elvis

4 months ago

Using earnings for funding is a solid move!

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Aliza

5 months ago

Wait, how did they come up with 9.20%? Sounds off.

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Laurel

5 months ago

12.20% seems too high given the debt levels.

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Mel

5 months ago

I think the expected return should be around 10%.

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Elenora

5 months ago

DQZ's beta is .60, so lower risk!

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Julieta

6 months ago

I feel like the answer might be around 10%, but I'm not completely confident in my calculations. I hope I remember the formula correctly!

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Gail

6 months ago

If I recall correctly, the risk-free rate is 5% and the market return is 12%. So, I guess I need to calculate the market premium first.

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Willis

6 months ago

I think the expected return should be calculated using the risk-free rate plus the market premium adjusted by beta. I practiced a similar question last week.

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Raelene

6 months ago

I remember we discussed CAPM in class, but I'm a bit unsure about how to apply the beta in this context.

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Lilli

6 months ago

This is a tricky one. Lots of moving parts to keep track of. I better double-check my work to make sure I don't miss anything important. Gotta nail this CAPM calculation.

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Francoise

6 months ago

Okay, I think I've got this. The key is to calculate the after-tax cost of debt, then use that along with the cost of equity to find the weighted average cost of capital. The CAPM formula should give me the expected rate of return.

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Zena

6 months ago

Hmm, I'm a little unsure about how to handle the flotation costs on the bonds. Do I need to adjust the coupon rate or the yield to account for that? And what's the impact of the tax rate on the cost of debt?

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Leonard

6 months ago

This looks like a pretty straightforward CAPM calculation. I'll need to find the cost of debt, cost of equity, and then combine them based on the capital structure to get the expected rate of return.

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Sarah

6 months ago

This is a tricky one. The input data and the DATA step look straightforward, but I'm not confident I'm interpreting the results correctly. I'll need to carefully consider each option and think through the implications.

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Lenita

11 months ago

I don't know, but I'm hoping the exam won't be a 'DQZ' for me. Get it? Haha, I'll see myself out.

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Denna

11 months ago

A) 9.20 percent. I'm a bit rusty on CAPM, but I think that's the right answer. Wait, isn't CAPM just a fancy way to say 'educated guess'?

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Filiberto

11 months ago

D) 10.00 percent. I'm not sure about the exact calculation, but that number feels more in line with the information provided.

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Stefania

10 months ago

I agree with D) 10.00 percent. It seems to make sense based on the information given.

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Margery

10 months ago

I believe it's B) 12.20 percent.

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Dorinda

10 months ago

I think the answer is A) 9.20 percent.

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Roy

11 months ago

C) 7.20 percent seems more plausible to me. With the given information, the CAPM calculation should result in a lower expected rate of return.

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Huey

11 months ago

D) 10.00 percent.

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Davida

11 months ago

C) 7.20 percent.

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Sabina

11 months ago

B) 12.20 percent.

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Youlanda

11 months ago

A) 9.20 percent.

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Tatum

12 months ago

I think the answer is B) 12.20 percent. The CAPM formula takes into account the risk-free rate, the expected market return, and the company's beta, which all add up to 12.20 percent.

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