Corporate Finance Exam 3

Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than the firm's average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT? Question 8 options: a) Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment. b) The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return. c) The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rs, then it should reject the project. d) The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return. e) Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision.

The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rs, then it should reject the project.

Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? Question 1 options: a) A Division A project with an 11% return. b) A Division B project with an 11% return. c) A Division B project with a 13% return. d) A Division A project with a 9% return. e) A Division B project with a 12% return.

a) A Division A project with an 11% return.

Which of the following statements is CORRECT? Question 9 options: a) During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future. b) If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0. c) If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm. d) The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. e) Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.

a) During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500, while Firm W's earnings and stock price move counter cyclically with M and other S&P companies. Both M and W estimate their costs of equity using the CAPM, they have identical market values, their standard deviations of returns are identical, and they both finance only with common equity. Which of the following statements is CORRECT? Question 2 options: a) If M and W merge, then the merged firm MW should have a WACC that is a simple average of M's and W's WACCs. b) M and W should have identical WACCs because their risks as measured by the standard deviation of returns are identical. c) Since M and W move counter cyclically to one another, if they merged, the merged firm's WACC would be less than the simple average of the two firms' WACCs. d) Without additional information, it is impossible to predict what the merged firm's WACC would be if M and W merged. e) M should have the lower WACC because it is like most other companies, and investors like that fact.

a) If M and W merge, then the merged firm MW should have a WACC that is a simple average of M's and W's WACCs.

Which of the following statements is CORRECT? Question 9 options: a) If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall. b) Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt. c) When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation. d) All else equal, an increase in a company's stock price will increase its marginal cost of new common equity, re. e) All else equal, an increase in a company's stock price will increase its marginal cost of retained earnings, rs.

a) If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT? Question 10 options: a) If a stock has a negative beta, its required return under the CAPM would be less than 5%. b) If a stock's beta doubled, its required return under the CAPM would also double. c) If a stock's beta doubled, its required return under the CAPM would more than double. d) If a stock's beta were 1.0, its required return under the CAPM would be 5%. e) If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.

a) If a stock has a negative beta, its required return under the CAPM would be less than 5%.

When working with the CAPM, which of the following factors can be determined with the most precision? Question 3 options: a) The beta coefficient of "the market," which is the same as the beta of an average stock. b) The market risk premium (RPM). c) The beta coefficient, bi, of a relatively safe stock. d) The most appropriate risk-free rate, rRF. e) The expected rate of return on the market, rM.

a) The beta coefficient of "the market," which is the same as the beta of an average stock.

Which of the following factors should be included in the cash flows used to estimate a project's NPV? Question 2 options: a) The end-of-project recovery of any additional net operating working capital required to operate the project. b) All costs associated with the project that have been incurred prior to the time the analysis is being conducted. c) Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes. d) Cannibalization effects, but only if those effects increase the project's projected cash flows. e) Interest on funds borrowed to help finance the project.

a) The end-of-project recovery of any additional net operating working capital required to operate the project.

Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall economy. The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project. Also, the new project's sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong. On the basis of this information, which of the following statements is CORRECT? Question 1 options: a) The proposed new project would have more stand-alone risk than the firm's typical project. b) The proposed new project would have less stand-alone risk than the firm's typical project. c) The proposed new project would increase the firm's market risk. d) The proposed new project would not affect the firm's risk at all. e) The proposed new project would increase the firm's corporate risk.

a) The proposed new project would have more stand-alone risk than the firm's typical project.

Which of the following statements is CORRECT? Question 9 options: a) Using bonus depreciation rather than straight line depreciation normally has the effect of receiving depreciation cash flows immediately and thus increasing a project's forecasted NPV. b) Corporations must use the same depreciation method for both stockholder reporting and tax purposes. c) Using bonus depreciation rather than straight line depreciation normally has the effect of delaying the receipt of depreciation cash flows and thus reducing a project's forecasted NPV. d) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. e) Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.

a) Using bonus depreciation rather than straight line depreciation normally has the effect of receiving depreciation cash flows immediately and thus increasing a project's forecasted NPV.

Inflation, recession, and high interest rates are economic events that are best characterized as being Question 6 options: a) among the factors that are responsible for market risk. b) irrelevant except to governmental authorities like the Federal Reserve. c) risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. d) systematic risk factors that can be diversified away. e) company-specific risk factors that can be diversified away.

a) among the factors that are responsible for market risk.

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio? Question 10 options: a) Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. b) Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk. c) Adding more such stocks will increase the portfolio's expected rate of return. d) Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. e) Adding more such stocks will have no effect on the portfolio's risk.

b) Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Which of the following statements is CORRECT? Question 7 options: a) Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. b) An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. c) The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. d) An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. e) It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.

b) An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

Which of the following statements is CORRECT? Question 7 options: a) An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they are both "objective" as opposed to "subjective," hence little or no judgment is required. b) Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm's stockholders are well diversified. c) If the calculated beta underestimates the firm's true investment risk—i.e., if the forward-looking beta that investors think exists exceeds the historical beta—then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high. d) The discounted cash flow method of estimating the cost of equity cannot be used unless the growth rate, g, is expected to be constant forever. e) The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach.

b) Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm's stockholders are well diversified.

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM? Question 7 options: a) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. b) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. c) Stock Y's return has a higher standard deviation than Stock X. d) Stock Y's realized return during the coming year will be higher than Stock X's return. e) If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.

b) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT? Question 8 options: a) When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process. b) In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it. c) Since depreciation is a non-cash expense, it has no impact on a project's calculated NPV.. d) Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis. e) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward.

b) In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it.

Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. ​ Stock Expected Return Standard Deviation ​ Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT? Question 4 options: a) Portfolio AB's coefficient of variation is greater than 2.0. b) Portfolio ABC's expected return is 10.66667%. c) Portfolio ABC has a standard deviation of 20%. d) Portfolio AB has a standard deviation of 20%. e) Portfolio AB's required return is greater than the required return on Stock A.

b) Portfolio ABC's expected return is 10.66667%.

Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects? Question 5 options: a) Project A, which has average risk and an IRR = 9%. b) Project B, which has below-average risk and an IRR = 8.5%. c) Project C, which has above-average risk and an IRR = 11%. d) Without information about the projects' NPVs we cannot determine which one or ones should be accepted. e) All of these projects should be accepted as they will produce a positive NPV.

b) Project B, which has below-average risk and an IRR = 8.5%.

Which of the following statements is CORRECT? Question 8 options: a) Two securities with the same stand-alone risk must have the same betas. b) The slope of the security market line is equal to the market risk premium. c) Lower beta stocks have higher required returns. d) Diversifiable risk cannot be completely diversified away. e) A stock's beta indicates its diversifiable risk.

b) The slope of the security market line is equal to the market risk premium.

A company's perpetual preferred stock currently sells for $127.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? Question 4 options: a) 6.87% b) 5.88% c) 6.60% d) 8.26% e) 8.06%

c) 6.60%

Which of the following statements is CORRECT? Question 9 options: a) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. b) The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. c) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock. d) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. e) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.

c) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT? Question 3 options: a) If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. b) Since the market is in equilibrium, the required returns of the two stocks should be the same. c) If both expected inflation and the market risk premium (rM - rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. d) If both expected inflation and the market risk premium (rM - rRF) increase, the required returns of both stocks will increase by the same amount. e) If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.

c) If both expected inflation and the market risk premium (rM - rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.

Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.) Question 5 options: a) Stock B has a higher required rate of return than Stock A. b) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. c) Portfolio P has a beta of 1.0. d) Portfolio P has a standard deviation of 22.5%. e) More information is needed to determine the portfolio's beta.

c) Portfolio P has a beta of 1.0.

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT: Question 3 options: a) A decline in the sales of an existing product, provided that decline is directly attributable to this project. b) The salvage value of assets used for the project that will be recovered at the end of the project's life. c) Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. d) Changes in net operating working capital attributable to the project. e) The value of a building owned by the firm that will be used for this project.

c) Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter? Question 8 options: a) Either A or B, i.e., the investor should be indifferent between the two. b) Neither A nor B, as neither has a return sufficient to compensate for risk. c) Stock B. d) Stock A. e) Add A, since its beta must be lower.

c) Stock B.

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false? Question 1 options: a) The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. b) The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. c) The beta of the portfolio is lower than the lowest of the three betas. d) The beta of the portfolio is higher than the beta of one or two of the stocks in the portfolio. e) The beta of the portfolio is calculated as a weighted average of the individual stocks' betas.

c) The beta of the portfolio is lower than the lowest of the three betas.

Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated? Question 7 options: a) The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another company, or used in the future to produce another of the firm's products. b) The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment. c) The company has spent and expensed for tax purposes $3 million on research related to the new product. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future. d) The new product will cut into sales of some of the firm's other products. e) If the project is accepted, the company must invest an additional $2 million in net operating working capital (NOWC). However, all these funds will be recovered at the end of the project's life.

c) The company has spent and expensed for tax purposes $3 million on research related to the new product. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future.

Which of the following statements is CORRECT? Question 3 options: a) A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. b) A two-stock portfolio will always have a lower beta than a one-stock portfolio. c) If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. d) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. e) A stock with an above-average standard deviation must also have an above-average beta.

d) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

The relative risk of a proposed project is best accounted for by which of the following procedures? Question 4 options: a) Ignoring risk because project risk cannot be measured accurately. b) Picking a risk factor equal to the average discount rate. c) Adjusting the discount rate upward if the project is judged to have below-average risk. d) Adjusting the discount rate upward if the project is judged to have above-average risk. e) Reducing the NPV by 10% for risky projects.

d) Adjusting the discount rate upward if the project is judged to have above-average risk.

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT? Question 6 options: a) If a stock's beta doubles, its required return must also double. b) An index fund with beta = 1.0 should have a required return less than 11%. c) An index fund with beta = 1.0 should have a required return greater than 11%. d) An index fund with beta = 1.0 should have a required return of 11%. e) If a stock has a negative beta, its required return must also be negative.

d) An index fund with beta = 1.0 should have a required return of 11%.

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio? Question 4 options: a) Variance; correlation coefficient. b) Beta; beta. c) Beta; variance. d) Coefficient of variation; beta. e) Standard deviation; correlation coefficient.

d) Coefficient of variation; beta.

Cranberry Corp. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT? Question 10 options: a) While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant's recommendation, this should not affect the firm's intrinsic value. b) The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm's capital structure but it will not affect its intrinsic value. c) The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time. d) The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm's intrinsic value over time. e) The decision not to risk adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time.

d) The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm's intrinsic value over time.

Which of the following statements is CORRECT? Question 5 options: a) An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity. b) The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds. The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal or is available online. c) The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used. d) The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm's target capital structure. e) Beta measures market risk, which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true unless all of the firm's stockholders are well diversified.

d) The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm's target capital structure.

Other things held constant, which of the following would increase the NPV of a project being considered? Question 6 options: a) An increase in required net operating working capital (NOWC). b) An increase in the discount rate associated with the project. c) Making the initial investment in the first year rather than spreading it over the first three years. d) The project would decrease sales of another product line. e) A shift from straight-line to bonus depreciation.

e) A shift from straight-line to bonus depreciation.

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? Question 6 options: a) Common stock. b) Retained earnings. c) Long-term debt. d) Preferred stock. e) Accounts payable.

e) Accounts payable.

Which of the following statements is CORRECT? Question 5 options: a) A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. b) A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. c) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. d) A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. e) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

e) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear--there is no mortgage on it. Which of the following statements is CORRECT? Question 10 options: a) Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows of the capital budgeting analysis for any new project. b) This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider. c) If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building. d) Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects. e) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.

e) If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.

Which of the following statements is CORRECT? Question 2 options: a) If a company's beta doubles, then its required rate of return will also double. b) If a company's beta were cut in half, then its required rate of return would also be halved. c) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. d) Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. e) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

e) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Over the past 89 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last? Question 2 options: a) Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. b) U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. c) Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. d) Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. e) Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

e) Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? Question 1 options: a) The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. b) The beta of the portfolio is larger than the weighted average of the betas of the individual stocks. c) The beta of the portfolio is less than the weighted average of the betas of the individual stocks. d) The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. e) The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.

e) The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.