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AICPA Exam CPA-Business Topic 2 Question 95 Discussion
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.
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.
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