Confidence boosters (easy and straightforward :-))

These questions are from Allen Resources website. Vignette: Justin Brooks is the Senior Portfolio Manager at Wyoming Bank and Trust. Justin manages several of the mutual funds on behalf of the bank and its clients. Justin is mentoring a new associate to the bank who will be assisting him with the management of the funds. Justin is explaining the concepts of Modern Portfolio Theory. Question: Which of the following is not an assumption of the Capital Market Theory? a) Investors must not be Markowitz Efficient b) All investors have the same expectations of risk and return (homogeneous) c) Taxes and transaction costs do not exist d) All investors can borrow or lend at the risk-free rate --------------------------------------- Vignette: Tasty Food Company has hired Julie Child as an assistant to the vice president of finance David Dime. During the last few years the company has not made many new capital investments due to the high cost of capital. The cost of capital has resulted in a greater focus within the company on the important decisions related to capital which Julie must be prepared to deal with. Question: TFCs target or optimal capital structure is: a) The mix of debt, preferred and common equity that minimizes the cost of capital b) The mix of debt, preferred and common equity that minimizes the cost of equity c) The mix of debt, preferred and common equity that causes the stock price to be maximized. d) The mix of debt, preferred and common equity that causes the year end reported earnings to be maximized. ----------------------- These type of questions will be gems for us in the exam :-).

You’ll find me doing cartwheel in the midst of the exam, if any such question makes it to the L2 exam on 7th. A and C else I retire…

A and C

A and A for the second one…don’t you wanna minimize your cost of capital (your WACC)!?

Dinesh, one of us two is retiring because I think the second one is A.

yeah, I think it’s A as well, why C?

Yep second one is A. The optimal capital structure is the one that minimizes WACC.

a, a first one is obvious. for the 2nd question you want to minimize WACC and maximize firm value, not stock price

A and A

A and A too. The second question was a little tricky because obviously the company is not at the optimal capital structure, but it should be the one that minimizes WACC and maximizes the company value.

A and A

A and A


C’mon guys! its A & C!

the minimize your WACC answer assumes everything is static. what happens if a project comes that yields 30% per year, your WACC is 8%, and the WACC cost of new project is 8.5%. it will raise your WACC, but it is highly profitable. now if you fix the investment portfolio then absolutely minimize WACC. in real world, i’d say maximize your stock price



This is not real world, its CFA world A A like A&A annonymous


AA westbruin…minimizing WACC doesn’t imply that you have to forego positive NPV calculations. Minimizing WACC is not a static concept, it will fluctuate given capital needs at the time as well as market conditions…it is the mix of debt, common & pfd stock that minimizes your cost of capital.