Finance Final

A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 14.2%, what is the stock price?

$11.98

A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 14.1%, and the constant growth rate is g = 4.0%. What is the current stock price?

$15.45

Reddick Enterprises' stock currently sells for $24.50 per share. The dividend is projected to increase at a constant rate of 5.50% per year. The required rate of return on the stock, rS, is 9.00%. What is the stock's expected price 3 years from today?

$28.77

A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 8.2%. What is the stock's current price?

$32.61

Mooradian Corporation's free cash flow during the just-ended year (t = 0) was $250 million, and its FCF is expected to grow at a constant rate of 5.0% in the future. If the weighted average cost of capital is 12.5%, what is the firm's total corporate value, in millions?

$35,000

Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 5.25% per year. The required rate of return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from now?

$45.53

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.50. What will the portfolio's new beta be? Do not round your intermediate calculations.

1.15 1. Find weight of stock in portfolio (Value of stock/ Value of portfolio) 2. Solve by using New Portfolio Beta equation = Old Beta - Weighted beta of SOLD stock + Weighted beta of PURCHASED stock

Mike Flannery holds the following portfolio: Stock Investment Beta A $150,000 1.40 B $10,000 0.80 C $140,000 1.00 D $75,000 1.20 Total $375,000 What is the portfolio's beta? Do not round your intermediate calculations.

1.19 1. Divide Investment/Toal 2. Multiple by Beta 3. Add Total

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 21.5% and a beta of 1.70. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock? Do not round your intermediate calculations.

12.05%; 1.25

If D1 = $1.50, g (which is constant) = 2.1%, and P0 = $56, what is the stock's expected capital gains yield for the coming year?

2.10%

Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 54% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) Do not round your intermediate calculations. Year ECB WCB 1 40.00% 40.00% 2 -10.00% 15.00% 3 35.00% -5.00% 4 -5.00% -10.00% 5 15.00% 35.00% Avg. return = 15.00% 15.00% Stand. Dev.= 22.64% 22.64%

3.99%

Company A has a beta of 0.70, while Company B's beta is 1.45. The required return on the stock market is 9.00%, and the risk-free rate is 2.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.) Do not round your intermediate calculations.

5.06% = RFR + (Required return on stock - RFR) * Beta

Dothan Inc.'s stock has a 25% chance of producing a 16% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return? Do not round your intermediate calculations.

5.50% (.24)(.16) + (.50)(.12) + (.25)(-.18) = 0.055

If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $40.00, what is the stock's expected total return for the coming year

8.13%

If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $40, what is the stock's expected total return for the coming year?

8.63%

Cooley Company's stock has a beta of 1.28, the risk-free rate is 2.25%, and the market risk premium is 5.50%. What is the firm's required rate of return? Do not round your intermediate calculations.

9.29% RROR = RFR + (MRP) * BETA = 2.25% + (5.50%) * 1.28 = 9.29%

Stock A's stock has a beta of 1.30, and its required return is 13.75%. Stock B's beta is 0.80. If the risk-free rate is 2.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.) Do not round your intermediate calculations.

9.52%

For which capital component must you make a tax adjustment when calculating a firm's weighted average cost of capital (WACC)?

Debt

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk. (T/F)

False

The slope of the SML is determined by the value of beta. (T/F)

False

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT? a. If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%. b. If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%. c. If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%. d. The required return on the market is 10%. e. The portfolio's required return is less than 11%.

If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%. (If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%" is correct. The portfolio's beta is 1.08. Therefore, if the market risk premium increases by 2.0% the portfolio's required return will increase by 2.16%)

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?

Stock B, with only 4 stocks in the portfolio, unsystematic risk matters, and B has less

A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT? a. The company's expected capital gains yield is 5%. b. The company's current stock price is $20. c. The constant growth model cannot be used because the growth rate is negative. d. The company's expected stock price at the beginning of next year is $9.50. e. The company's dividend yield 5 years from now is expected to be 10%.

The company's expected stock price at the beginning of next year is $9.50. P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5% each year, so P1 must be $10(0.95) = $9.50. Therefore, "The company's expected stock price at the beginning of next year is $9.50" is correct, while all the others are false.

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

The required return on Portfolio P would increase by 1%

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

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

If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium. a. The expected return on the stock is 5% a year. b. The stock's required return must be equal to or less than 5%. c. The price of the stock is expected to decline in the future. d. The stock's dividend yield is 5%. e. The stock's price one year from now is expected to be 5% above the current price.

The stock's price one year from now is expected to be 5% above the current price Why: because the stock price is expected to grow at the dividend growth rate.

Red Lemon is considering investing in a project in which the risk is greater than the firm's current risk based on any method for assessing risk. Which of the following should management do when evaluating this project? a. They should always reject the project, because it will increase the firm's risk level. b. To take the higher risk level into account, they will need to increase the flotation expenses associated with the project. c. To take the higher risk level into account, they will need to change the weights on the capital components. d. To take the higher risk level into account, they will need to use a discount rate that is greater than the cost of capital to evaluate the project.

To take the higher risk level into account, they will need to use a discount rate that is greater than the cost of capital to evaluate the project.

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM. (T/F)

True

Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm's total corporate value. (T/F)

True

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse. (T/F)

True

Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk. (T/F)

True

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? 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. 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. c. 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. 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. Since the market is in equilibrium, the required returns of the two stocks should be the same.

b. 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.

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X Y Price $30 $30 Expected growth (constant) 6% 4% Required return 12% 10% a. Stock Y has a higher capital gains yield. b. One year from now, Stock X's price is expected to be higher than Stock Y's price. c. Stock X has a higher dividend yield than Stock Y. d. Stock X has the higher expected year-end dividend.

b. One year from now, Stock X's price is expected to be higher than Stock Y's price. Both prices are currently the same, but X's price should grow at 6% vs. 4% for Y, so X's price should be higher a year from now.

Which of the following statements is CORRECT? a. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. b. If a stock has a negative beta, its expected return must be negative. c. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. d. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. e. A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.

c. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12% a. The two stocks could not be in equilibrium with the numbers given in the question. b. A's expected dividend is $0.50. c. A's expected dividend is $0.63 and B's expected dividend is $1.20. d. B's expected dividend is $0.75. e. The two stocks should have the same expected dividend

c. A's expected dividend is $0.63 and B's expected dividend is $1.20. = 25(.10) - 25(.07) = .75 = 40(.12) - 40(.09) = 1.20

Which of the following statements is CORRECT? a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. b. 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. c. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 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. 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. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT? a. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. b. Stock A must have a higher dividend yield than Stock B. c. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. d. Stock B must have a higher dividend yield than Stock A. e. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's.

c. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. Stock B's required return is double that of Stock A's. b. An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. c. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. d. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. e. If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.

c. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT? a. The two stocks must have the same dividend per share. b. If one stock has a higher dividend yield, it must also have a higher dividend growth rate. c. If one stock has a higher dividend yield, it must also have a lower dividend growth rate. d. The two stocks must have the same dividend growth rate. e. The two stocks must have the same dividend yield.

d. The two stocks must have the same dividend growth rate

Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT? a. All common stocks fall into one of three classes: A, B, and C. b. All common stocks, regardless of class, must have the same voting rights. c. All firms have several classes of common stock. d. All common stock, regardless of class, must pay the same dividend. e. Some class or classes of common stock are entitled to more votes per share than other classes.

e. Some class or classes of common stock are entitled to more votes per share than other classes

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT? a. The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase. b. The required return of all stocks will remain unchanged since there was no change in their betas. c. The required returns on all three stocks will increase by the amount of the increase in the market risk premium. d. The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease. e. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

e. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

If in the opinion of a given investor a stock's expected return exceeds its required return, this suggests that the investor thinks

the stock is a good buy.