FRL 301 Midterm 2
The common stock of Manchester & Moore is expected to earn 13 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate return on this stock?
8.65 percent E(r) = (0.45 x 0.13) + (0.50 x 0.06) + (0.05 x -o.o4) = 8.65 percent
Nelson Paints recently went public by offering 65,000 shares of common stock to the public. The underwriters provided their services in a best efforts underwriting. The offering price was set at $16 a share and the gross spread was $2. After completing their sales efforts, the underwriters determined that they sold a total of 57,500 shares. How much cash did Nelson Paints receive from its IPO?
$805,000 Total cash received = 57,500 × ($16 - $2) = $805,000
Jennifer owns 14,000 shares of Calico Clothing. Currently, there are 1.6 million shares of stock outstanding. The company has just announced a rights offering whereby 200,000 shares are being offered for sale at a subscription price of $14 a share. The current stock price is $16 a share. Assume that Jennifer sells her rights and that all rights are exercised. What percentage of the firm will Jennifer own after the rights offering?
0.78 percent New ownership percentage = 14,000/(1.6m + 0.2m) = 0.78 percent
Henessey Markets has a growth rate of a 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?
10.6 percent Re= (0.106 - 0.087) + (1.00 x 0.087) = 10.6
Delta Lighting has 30,000 shares of common stock outstanding at a market price of $15.00 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 13 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?
10.87 percent Common: 30,000 x 15.00 = $450,000 Debt: $280,000 x 0.86 = $240,800 Total = $690,800 WACC = (450,000/690,800 * .13) + (240,800/690,800 * .069) = 10.87 percent
Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 5.4 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?
2.77 WACC = 0.08 = [We × 0.152] + [(1 - We) × 0.054)] We = 0.2653; Wd = 1 - We = 0.7347 Debt-equity ratio = 0.7347/0.2653 = 2.77
Northwest Rail wants to raise $14.2 million through a rights offering so it can purchase additional rail cars and upgrade its maintenance facilities. How many shares of stock will the firm need to sell through this offering if the current market price is $34 a share and the subscription price is $31 a share?
453,604 shares $14.2m/$31 = 458,064.52 shares
Mangrove Fruit Farms has a $250,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock. What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?
8.17 percent Debt: $250,000 x 0.92 = $230,000 Preferred: 1,500 x $35 = $52,000 Common: 15,000 x $24 = $360,000 Total = $642,500 Weightpreferred = $52,500/$642,500 = 8.17 percent
You own a portfolio with the following expected returns given the various states of the economy. What is the overall portfolio expected return? BOOM> probability = 27%, ROR = 17% NORMAL> probability= 70%, RoR= 8% RECESSION> Probability = 3%, RoR = -11%
9.86 percent E(r) = (0.27 x 0.17) + (0.03 x 0.08) + (0.03 x -0.11) = 9.86
The expected return on a portfolio considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III. the performance of each security given various economic states IV. probability of occurrence for each state of the economy
I, II, III, and IV (section 13.2)
Which one of the following statements concerning venture capital financing is correct?
Venture capitalists often require at least a forty percent equity position as a condition of financing. (15.1)
The expected return on a stock computed using economic probabilities is:
a mathematical expectation based on a weighted average and not an actual anticipated outcome (13.1)
Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public. The underwriters charged a fee of 8 percent and paid Blue Stone Builders $16.40 a share on 40,000 shares. Which one of the following terms best describes this underwriting?
best efforts (15.4)
Which on of the following is an example of unsystematic risk?
consumer spending on entertainment decreased nationality (13.4)
According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:
market risk premium and the amount of systematic risk inherent in the security (13.7)
The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:
market value of the investment in each stock. (section 13.2)
The expected risk premium on a stock is equal to the expected return on the stock minus the:
risk-free rate
The principle of diversification tells us that:
spreading an investment across many diverse assets will eliminate some of the total risk.
The ___ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.
systematic risk principle
Which one of the following risks is irrelevant to a well-diversified investor?
unsystematic risk
The expected return on a stock given various states of the economy is equal to the:
weighted average of the returns for each economic state.
