FIN 300 FINAL USM STELK

Suppose you are considering buying a stock. The stock is currently trading for $298. You expect the price in one year to be $301 and it will pay a dividend of $4. You estimate the stock's beta at 1.2, the risk-free rate at 3%, and the expected return on the market at 9%. According to the CAPM, what is the maximum price you should be willing to pay for this stock? LO3

$276.77

Suppose you are considering buying a stock. You expect the stock to pay a dividend of $2 one year from today and that the dividend will grow 3% each year after that. Using the CAPM, you estimate your required return at 8% to compensate you for the risk of this stock's cash flows. What is the maximum price you are willing to pay for a share of the stock? LO3

$40

Suppose you have a portfolio equally invested in four stocks. Each stock's expected return, standard deviations, and beta are in the following table. What is your portfolio's beta? LO4

0.625

A one-year $1,000 T-bill is priced at $990. What yield is it offering? LO2

1.01%

You use the CAPM to estimate Stock J's required return at 7%. If the risk-free rate is 2% and the expected return on the market portfolio is 5%. What is your estimate for Stock J's beta? LO3

1.67

Suppose a 15-year $1,000 2% Treasury note with semiannual coupon payments is priced at $980.50. What is the yield to maturity at the current price? LO2

2.15%

A share of preferred stock is currently trading for $80 and pays a dividend of $2 per year, with the next dividend due one year from today. What is your expected rate of return if you were to buy the stock today?

2.5%

Suppose Stock A has the following returns over the last five years: 8%, 5%, 9%, 2%, and −2%. What is the realized annual return? LO2

4.32%

Suppose Stock A has the following returns over the last five years: 8%, 5%, 9%, 2%, and −2%. What is the average annual return? LO2

4.4%

Suppose you are considering buying a stock. The stock is currently trading for $105. You expect the price in one year to be $110 and it will pay a dividend of $2. What is the capital gains? LO4

4.76%

Suppose you are considering buying a stock with a beta of 0.7. What is your required return given by the CAPM if the expected return on the market is 8%, the risk-free rate is 1%? LO3

5.9%

You are estimating your firm's WACC to evaluate potential investments. The firm has outstanding preferred stock trading for $40 that pays an annual dividend of $3. You estimate the firm's common equity beta at 1.0 and the expected return on the market at 10%. The risk-free rate is 1%. The firm's current bonds are trading at a YTM of 8% and the firm's marginal tax rate is 35%. The firm's target capital structure is 30% common equity, 8% preferred stock, and 62% debt. What is the firm's WACC? LO1

6.82%

An investor purchased a 30-year 4.3% Treasury bond at the issue price of 96.12 on June 1, 2019. As the COVID-19 pandemic unfolded, investors fled to investments perceived as safe and purchased large quantities of Treasury securities. The increased demand pushed Treasury prices up. On June 1, 2020, exactly one year after buying the T-bond, the investor sold it for 121.35 after receiving two-coupon payments. What was the yield to maturity when the investor purchased the bond? What was the investor's realized return, stated as an APR, when she sold the bond? LO2

? 28.9505 ?

Which of the following bonds will have the greatest price sensitivity to changes in yield? That is, which bond will experience the largest percentage change in price for a given change in yield? Assume all listed bonds have the same face value and credit rating. LO3

A 30-year 5% coupon bond.

Which of the following statements about how bond prices change over time is TRUE. LO5

A bond's price tends to move closer to face value as the maturity date gets closer.

Which of the following statements about preferred stock is FALSE? LO1

A share of preferred stock offers the owner a right to vote on the corporation's major decisions.

A stock with a beta of 2 tends to have returns that are _________________. LO3

About twice as volatile than the market's returns.

You are trying to choose between two mutually exclusive projects whose expected cash flows are in the following table. You estimate the risk-adjusted WACC for both projects at 9%. What should you do? LO3

Accept project B because it has a higher NPV.

You are trying to choose between two mutually exclusive projects whose expected cash flows are in the following table. You estimate the risk-adjusted WACC for both projects at 9%. What should you do? LO3 YearProject AProject B0−$1,000,000−$1,000,0001$200,000$600,0002$400,000$400,0003$600,000$200,000

Accept project B because it has a higher NPV.

Which of the following is true about market risk? LO1

All of these.

Which of the following is true about the CAPM theory and is important to keep in mind when using the model to estimate your minimum required rate of return for an asset? LO5

All of these.

Which of the following statements about common stock is TRUE? LO1

All of these.

Which of the following is true about beta? LO1

Beta measures an asset's exposure to market risk.

You are considering purchasing a stock. Using the DDM and CAPM, you calculate the stock's expected return at 15%. The CAPM gives a required return of 12%. What should you do and why should you do it? LO5

Buy the stock because it offers a high enough return to justify its risk.

Why do corporate bonds tend to offer higher interest rates than U.S. Treasury securities of similar maturity? LO4

Corporate bonds tend to have more default risk than similar maturity Treasuries, so investors demand higher yields to compensate for the increased risk.

Suppose you are considering buying a stock. The stock is currently trading for $105. You expect the price in one year to be $110 and it will pay a dividend of $2. What is the dividend yield? LO4

Dividend Yield=$2/$105= 0.0190

You are considering purchasing a stock. Using the DDM and CAPM, you calculate the stock's intrinsic value at $101. The stock is currently trading at $105. What should you do and why should you do it? LO5

Do not buy the stock because it does not offer a high enough return to justify its risk.

A large enough portfolio will eliminate all risk. LO1

FALSE

All four investment rules discussed in this chapter will give the same investment decision if there are no calculation mistakes. LO4

FALSE

Bonds with higher risk and lower credit ratings tend to offer lower yields to attract investors. LO4

FALSE

Financial managers should use accounting-based book values instead of market values to calculate weights for the firm's WACC. LO1

FALSE

The intrinsic value of a dividend-paying stock cannot be determined because the share does not mature and pays dividends forever. The intrinsic value is effectively infinite.

FALSE

The risk of a portfolio increases as you add more stocks with correlation coefficients less than one to the portfolio. LO1

FALSE

Which of the following is true about a stock's price? LO2

Holding all else constant, a stock's price should increase when a corporation's expected future earnings increase.

Stock X and Stock Y each have a standard deviation of 40%. If the stocks have a correlation coefficient less than one, then a portfolio of the two stocks has a standard deviation of _________________. LO1

Less than 40%

Which of the following is TRUE about NPV? LO3

NPV is the difference between the present value of the benefits and the present value of the costs of a project.

Suppose you have a portfolio equally invested in four stocks. Each stock's expected return, standard deviations, and beta are in the following table. Which stock is contributing the most risk to your portfolio? Which stock is reducing your portfolio's risk the most? LO1

Stock A is contributing the most risk. Stock D is reducing the portfolio's risk the most.

A bond will trade at a discount when its coupon rate is higher than the yield to maturity. LO1 and LO3

TRUE

The WACC is the minimum return a firm must earn on its investments in order to pay all financial stakeholders their required rates of return. LO1

TRUE

When holding stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks' returns are correlated. LO1

TRUE

Which of the following is an accurate description of a bond's maturity date? LO1

The date on which the bond pays its face value to the bondholder.

How is the intrinsic value of a share of common stock determined according to the Dividend Discount Model (DDM)? LO1

The intrinsic value is the present value of the expected future cash flows discounted at an appropriate rate given the cash flows' risk.

The required return of a stock given by the CAPM is _______________. LO1

The minimum return the average investor requires as compensation for the risk of holding the stock.

Suppose a two-year $1,000 3% bond with semiannual coupon payments offers a 5% yield. What price would an investor pay to buy this bond? If the yield holds constant at 5%, what is the price with exactly one year to maturity? LO2 and LO4

The price at the time if issue is $962.38 and the price with one year to maturity is $980.73.

A one-year $1,000 T-bill is offering a 5% yield. What price must an investor pay if she wants to buy the bond today? LO2

The price of the bond is $952.38.

A CEO who led a famous turnaround at a large corporation has just retired. A publishing company has offered to pay her $2,000,000 today to spend the next two years writing a book about her experiences. Accepting this opportunity means that the author will give up lucrative speech opportunities over the next two years while she works on the book. She expects to make $1,100,000 per year giving speeches over the next two years if she does not accept the publishing opportunity. The former CEO estimates that 8% is a reasonable cost of capital for this project. What does the NPV rule say about this project? What does the IRR rule say about this investment? Should she accept the publishing deal? LO3 and LO4

The project has a positive NPV, so the NPV rule says to accept the project. The project's IRR is less than the cost of capital, so the IRR rule says to reject the project. The author should accept the publishing deal.

Holding all else constant, what would you expect to happen to the price of a share of stock if the expected return on the market increased? Use the CAPM and DDM to answer this question. LO2

The stock's price would decrease because the discount rate increased.

You are deciding whether to buy Stock A. You estimate Stock A's beta at 0.3 and its expected return at 4% over the next year. The risk-free rate is 1.5% and you estimate the market portfolio's expected return at 6%. You are using the CAPM to decide if the stock's expected return is high enough to compensate you for the risk of holding the stock. Based on the CAPM, should you buy the stock? LO3

The stock's required return is 2.85%. Yes, you should buy it.

Which of the following is TRUE about a dividend paying stock's total expected return?

The total expected return comes from two sources: the dividend yield and capital gains.

An investor purchased a 20-year 3% Treasury note at the issue price of 106.20 on June 1, 2021. As the government response to COVID-19 pandemic continued, investors became worried about the U.S. government's ability to service its growing debt burden and sold large quantities of Treasury securities. The decreased demand pushed Treasury prices down. On June 1, 2022, exactly one year after buying the T-note, the investor sold it for 88.53 after receiving two-coupon payments. What was the yield to maturity when the investor purchased the note? What was the investor's realized return, stated as an APR, when she sold the note? LO2

The yield to maturity at purchase is 2.60%, while the rate of return at sale is −14.44%.

You are evaluating a project for your firm. The project will require an investment today of $650,000 and is expected to generate cash inflows of $150,000 at the end of the next three years. The machinery will need to be maintained or replaced four years from today, which will require a net cash outflow of $350,000. The project will then generate another three years' worth of $150,000 cash inflows (with the last cash inflow seven years from today). You estimate the project's risk-weighted WACC at 6%. How many potential IRRs does this project have? What does the IRR rule say about this investment? LO3 and LO4

There are three potential IRRs. The IRR rule does not apply to this project.