Finance Test 03 - North Georgia - Oppenheimer

Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? $1,105.69 $1,220.48 $1,133.34 $1,161.67 $1,190.71

$1,105.69 Par value $1,000 Coupon rate 9.5% Periods/year 2 Yrs to maturity 20 Periods = Yrs to maturity ´ Periods/year 40 Required rate 8.4% Periodic rate = Required rate/2 = I/YR 4.20% PMT per period = Coupon rate/2 ´ Par value $47.50 Maturity value = FV $1,000 PV $1,105.69

Kale Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11.0% and FCF is expected to grow at a rate of 5.0% after Year 2, what is the firm's total corporate value, in millions? (Free cash flows: EOY 1 = -$50; EOY 2 = $100) $1,606 $1,686 $1,456 $1,770 $1,529

$1,456 FCF1 -$50 FCF2 $100 g 5% WACC 11% First, find the horizon, or continuing, value: HV2 = FCF2(1 + g)/(WACC - g) = $100(1.05)/(0.11 - 0.05) = $1,750.00 Then find the PV of the free cash flows and the horizon value: Total corporate value = -$50/(1.11) + ($100 + $1,750)/(1.11)2 = $1,456.46

Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the stock sell? $112.50 $106.95 $104.27 $109.69 $115.38

$115.38 Preferred dividend $7.50 Required return 6.5% Preferred price = DP/rP = $115.38

Based on the corporate valuation model, Morgan Inc.'s total corporate value is $300 million. The balance sheet shows $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. The company has 10 million shares of stock outstanding. What is the best estimate of the stock's price per share? $12.00 $12.64 $13.30 $14.70 $14.00

$14.00 Assuming that the book value of debt is close to its market value, the total market value of the firm's equity is: Total corporate value $300 Notes payable -$ 90 Long-term debt -$ 30 Preferred stock -$ 40 MV equity $140 Shares outstanding 10 Stock price = Value of equity/Shares outstanding = $14.00 The book value of equity figures are irrelevant for this problem

Schnusenberg Corporation just paid a dividend of D0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price? $14.89 $15.26 $15.64 $16.03 $14.52

$14.52 D0 $0.75 b 1.25 rRF 4.5% rM 10.5% g 6.5% D1 = D0(1 + g) = $0.7988 rs = rRF + b(rM - RRF) = 12.0% P0 = D1/(rs - g) $14.52

A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price? $23.11 $24.93 $23.70 $25.57 $24.31

$25.57 D0 $1.50 rs 10.1% g 4.0% D1 = D0(1 + g) = $1.56 P0 = D1/(rs - g) $25.57

Suppose Boyson Corporation's projected free cash flow for next year is FCF1 = $150,000, and FCF is expected to grow at a constant rate of 6.5%. If the company's weighted average cost of capital is 11.5%, what is the firm's total corporate value? $3,000,000 $2,572,125 $2,707,500 $2,850,000 $3,150,000

$3,000,000 FCF1 $150,000 g 6.50% WACC 11.50% Total corporate value = FCF1/(WACC - g) = $3,000,000

Huang Company's last dividend was $1.25. The dividend growth rate is expected to be constant at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's required return (rs) is 11%, what is its current stock price? $30.57 $31.52 $33.50 $34.50 $32.49

$33.50 Horizon value = P2 = D3/(rs - g3) = Price = Sum of PVs = $33.50

Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 4.75% 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? $43.34 $40.17 $41.20 $42.26 $44.46

$44.46 Growth rate 4.75% Years in the future 5 Stock price $35.25 P5 = P0(1 + g)5 = $44.46

Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 8.2% on these bonds. What is the bond's price? $903.04 $925.62 $972.48 $948.76 $996.79

$903.04 N 8 I/YR 8.2% PMT $65 FV $1,000 PV $903.04

A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now? $930.11 $977.20 $953.36 $884.19 $906.86

$930.11

Bae Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation? 0.67 0.98 0.89 0.73 0.81

0.67 Expected return 15.0% Standard deviation 10.0% Coefficient of variation = std dev/expected return = 0.67

Keys Printing plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted? 0.77% 0.57% 0.70% 0.63% 0.85%

0.70% Difference = Cost at new rate - Cost at old rate =

Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium? 6.09% 6.25% 5.80% 5.95% 6.40%

5.80% Use the SML to determine the market risk premium with the given data. rs = rRF + bStock ´ RPM 12.25% = 5.00% + 1.25 ´ RPM 7.25% = RP M ´ 1.25 5.80% = RPM

Dyl Inc.'s bonds currently sell for $1,040 and have a par value of $1,000. They pay a $65 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to maturity (YTM)? 6.71% 5.78% 6.39% 7.05% 6.09%

6.09% Hide Feedback N 15 PV $1,040 PMT $65 FV $1,000 I/YR 6.09% = YTM

If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock's expected capital gains yield for the coming year? 6.50% 7.17% 7.90% 6.83% 7.52%

6.50% D1 $1.50 g 6.5% P0 $56.00 Capital gains yield = g = 6.50%

Sadik Inc.'s bonds currently sell for $1,180 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)? 7.35% 6.98% 8.12% 7.74% 6.63%

7.74% N 5 PV $1,180 PMT $105 FV $1,100 I/YR = YTC 7.74%

Daves Inc. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,050.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC? 8.79% 8.35% 7.93% 7.54% 7.16%

8.79%

O'Brien Ltd.'s outstanding bonds have a $1,000 par value, and they mature in 25 years. Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $975. What is the bond's nominal coupon interest rate? 7.32% 8.12% 7.71% 8.54% 8.99%

8.99%

Dothan Inc.'s stock has a 25% chance of producing a 30% 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? 9.00% 8.55% 9.50% 8.12% 7.72%

9.00% Conditions Prob. Return ´ Return Good 0.25 30.0% 7.50% Average 0.50 12.0% 6.00% Poor 0.25 -18.0% -4.50% 1.00 9.00% = Expected return

Bosio Inc.'s perpetual preferred stock sells for $97.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC? 9.82% 10.22% 8.72% 9.44% 9.08%

9.08% Preferred stock price $97.50 Preferred dividend $8.50 Flotation cost 4.00% rp = Dp/(Pp(1 - F)) 9.08%

You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.75%. The firm will not be issuing any new stock. What is its WACC? 8.98% 10.12% 9.83% 9.26% 9.54%

9.26% WACC = wd ´ rd ´ (1 - T) + wp ´ r p + wc ´ rs

If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock's expected total return for the coming year? 9.27% 9.03% 8.37% 8.59% 8.81%

9.27% D0 $1.75 g 3.6% P0 $32.00 D1 = D0(1 + g) = $1.81 Total return = rs = D1/P0 + g 9.27%

If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value? ] A 10-year bond with a 12% coupon. A 1-year bond with an 8% coupon. A 1-year zero coupon bond. A 10-year zero coupon bond. A 10-year bond with an 8% coupon.

A 10-year zero coupon bond.

Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par? The rating agencies change the bond's rating from Baa to Aaa. Making the bond a first mortgage bond rather than a debenture. Adding a sinking fund. Adding a call provision. Adding additional restrictive covenants that limit management's actions.

Adding a call provision.

Which of the following statements is CORRECT? 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. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

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

Gupta Corporation is undergoing a restructuring, and its free cash flows are expected to vary considerably during the next few years. However, the FCF is expected to be $65.00 million in Year 5, and the FCF growth rate is expected to be a constant 6.5% beyond that point. The weighted average cost of capital is 12.0%. What is the horizon (or continuing) value (in millions) at t = 5? $1,136 $1,025 $1,259 $1,079 $1,196

CF5 $65.00 g 6.5% WACC 12.0% FCF6 = FCF5(1 + g) = $69.2250 HV5 = FCF6/(WACC - g) = $1,258.64

A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation. False True

False

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held. True False

False

Suppose you are the president of a small, publicly-traded corporation. Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt. False True

False

The corporate valuation model can be used only when a company doesn't pay dividends. True False

False

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

If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. Statement a is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the growth rate for Stock A must be higher to offset this.

Which of the following statements is CORRECT? 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. All else equal, an increase in a company's stock price will increase its marginal cost of new common equity, re. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation. Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt. All else equal, an increase in a company's stock price will increase its marginal cost of retained earnings, rs.

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. Statement e is true, because the after-tax cost of debt is rd(1 - T). So, if rd remains constant but T increases, rd(1 - T) will decline. The other statements are all false.

Which of the following statements is CORRECT? An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. WACC calculations should be based on the before-tax costs of all the individual capital components. Flotation costs associated with issuing new common stock normally reduce the WACC. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. A change in a company's target capital structure cannot affect its WACC.

If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. Statement d is true, because the cost of debt for WACC purposes = rd(1 - T), so if T increases, then rd(1 - T) declines.

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

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

A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT? The bond's current yield is greater than 9%. If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price. The bond is selling below its par value. If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price. The bond is selling at a discount.

If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.

Which of the following events would make it more likely that a company would call its outstanding callable bonds? The company's financial situation deteriorates significantly. The company's bonds are downgraded. Market interest rates rise sharply. Inflation increases significantly. Market interest rates decline sharply.

Market interest rates decline sharply.

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% Stock X has the higher expected year-end dividend. Stock Y has a higher capital gains yield. One year from now, Stock X's price is expected to be higher than Stock Y's price. Stock X has a higher dividend yield than Stock Y. Stock Y has a higher dividend yield than Stock X.

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.

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.) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. Portfolio P has a beta of 1.0. Portfolio P has a standard deviation of 22.5%. Stock B has a higher required rate of return than Stock A. More information is needed to determine the portfolio's beta.

Portfolio P has a beta of 1.0.

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. True False

True

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms. False True

True

From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky. True False

True

If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC. Incorrect Response False Correct Answer True

True

Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength. True False

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. False True

True

The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities. True False

True

The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity. False True

True

The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant. True False

True

The text identifies three methods for estimating the cost of common stock from retained earnings: the CAPM method, the DCF method, and the bond-yield-plus-risk-premium method. Since we cannot be sure that the estimate obtained with any of these methods is correct, it is often appropriate to use all three methods, then consider all three estimates, and end up using a judgmental estimate when calculating the WACC. False True

True Unfortunately, this is true.

Mike Flannery holds the following portfolio: Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000 What is the portfolio's beta? 1.06 1.17 1.29 1.42 1.56

1.17 Stock Investment Percentage Beta Product A $150,000 40.00% 1.40 0.56 B $ 50,000 13.33% 0.80 0.11 C $100,000 26.67% 1.00 0.27 D $ 75,000 20.00% 1.20 0.24 Total $375,000 100.00% 1.17 = Portfolio Beta

The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm's bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.25. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference? 1.50% 2.58% 1.88% 1.13% 2.34%

1.50%

Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return? 9.92% 9.43% 9.67% 10.17% 10.42%

10.17% Real risk-free rate, r* 2.00% Expected inflation, IP 3.00% Market risk premium, RPM 4.70% Beta, b 1.10 Risk-free rate = r* + IP = 5.00% Kollo's required return = rRF + b(RPM) = 10.17%

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.) 10.88% 10.36% 11.15% 10.62% 11.43%

10.36% Beta 1.23 Risk-free rate 4.30% Required return on stock 11.75% RPM = (rstock - rRF)/beta 6.06% Required return on market = rRF + RPM = 10.36%

Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $27.50; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? 9.29% 10.08% 10.92% 9.68% 10.50%

10.50% D0 $0.90 P0 $27.50 g 7.00% D1 = D0 ´ (1 + g) $0.963 rs = D1/P0 + g 10.50%

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 13.0% and a beta of 1.50. 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? 11.20%; 1.23 11.76%; 1.29 12.97%; 1.42 12.35%; 1.36 10.64%; 1.17

11.20%; 1.23 Old portfolio return 11.0% Old portfolio beta 1.20 New stock return 13.0% New stock beta 1.50 % of portfolio in new stock = $ in New/($ in old + $ in new) = $10,000/$100,000 = 10% New expected portfolio return = rp = 0.1 ´ 13% + 0.9 ´ 11% = 11.20% New expected portfolio beta = bp = 0.1 ´ 1.50 + 0.9 ´ 1.20 = 1.23

O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of equity from retained earnings based on the CAPM? 11.99% 11.30% 11.64% 12.35% 12.72%

11.30% rRF 5.00% RPM 6.00% b 1.05 rs = rRF + b(RPM) 11.30%

You were recently hired by Scheuer Media Inc. to estimate its cost of capital. You obtained the following data: D1 = $1.75; P0 = $42.50; g = 7.00% (constant); and F = 5.00%. What is the cost of equity raised by selling new common stock? 11.33% 12.50% 10.77% 11.90% 13.12%

11.33% D1 $1.75 P0 $42.50 g 7.00% F 5.00% re = D1/(P0 ´ (1 - F)) + g 11.33%

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.) 14.38% 15.87% 15.49% 15.11% 14.74%

14.38% Risk-free rate 5.50% Old market risk premium 4.75% Old required return 11.75% b = (old return - rRF)/old RPM 1.32 New market risk premium 6.75% New required return = rRF + b(RPM) = 14.38%

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? Beta; beta. Variance; correlation coefficient. Standard deviation; correlation coefficient. Coefficient of variation; beta. Beta; variance.

Coefficient of variation; beta.

Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Beta 1.10 0.90 Constant growth rate 7.00% 7.00% Stock A must have a higher dividend yield than Stock B. Stock A must have a higher stock price than Stock B. Stock B's dividend yield equals its expected dividend growth rate. Stock B must have the higher required return. Stock B could have the higher expected return.

Stock A must have a higher dividend yield than Stock B. Stock A has a higher required return but the stocks have the same growth rate, so Stock A must have the higher dividend yield. Here are some calculations to demonstrate the point.

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT? The portfolio's standard deviation is greater than 20%. The portfolio's beta is less than 1.2. The portfolio's standard deviation is 20%. The portfolio's expected return is 15%. The portfolio's beta is greater than 1.2.

The portfolio's expected return is 15%.