FIN 160 Chapter 13

Assuming the CAPM or one-factor model holds, what is the cost of equity for a firm if the firm's equity has a beta of 1.2, the risk-free rate of return is 2%, the expected return on the market is 9%, and the return to the company's debt is 7%? A. 10.4% B. 10.8% C. 12.8% D. 14.4% E. None of the above.

A

If a firm has low fixed costs relative to all other firms in the same industry, a large change in sales volume (either up or down) would have: A. a smaller change in EBIT for the firm versus the other firms. B. no effect in any way on the firms as volume does not effect fixed costs. C. a decreasing effect on the cyclical nature of the business. D. a larger change in EBIT for the firm versus the other firms. E. None of the above.

A

If the risk of an investment project is different than the firm's risk then: A. you must adjust the discount rate for the project based on the firm's risk. B. you must adjust the discount rate for the project based on the project risk. C. you must exercise risk aversion and use the market rate. D. an average rate across prior projects is acceptable because estimates contain errors. E. one must have the actual data to determine any differences in the calculations.

B

The cost of equity for Ryan Corporation is 8.4%. If the expected return on the market is 10% and the risk-free rate is 5%, then the equity beta is ___. A. 0.48 B. 0.68 C. 1.25 D. 1.68 E. Impossible to calculate with information given.

B

A firm with high operating leverage has: A. low fixed costs in its production process. B. high variable costs in its production process. C. high fixed costs in its production process. D. high price per unit. E. low price per unit.

C

Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capital? A. 7.10% B. 7.39% C. 10.38% D. 10.65% E. 11.37%

C

The Norris Co. has an improved version of its hotel stand. The investment cost is expected to be $72 million and will return $13.5 million for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. The appropriate discount rate, assuming average risk, is: A. 8.65% B. 9% C. 9.47% D. 10.5% E. 13%

C

The Consolidated Transfer Co. is an all-equity financed firm. The beta is .75, the market risk premium is 8% and the risk-free rate is 4%. What is the expected return of Consolidated? A. 7% B. 8% C. 9% D. 10% E. 13%

D

The Hold-n-Trade Co. is an all-equity financed firm. The beta is .9, the market risk premium is 7% and the risk-free rate is 5%. What is the expected return of Hold-n-Trade? A. 8% B. 8.5% C. 9% D. 11.3% E. 12%

D

The beta of a security provides an: A. estimate of the market risk premium. B. estimate of the slope of the Capital Market Line. C. estimate of the slope of the Security Market Line. D. estimate of the systematic risk of the security. E. None of the above.

D

Suppose that the Simmons Corporation's common stock has a beta of 1.6. If the risk-free rate is 5% and the market risk premium is 4%, the expected return on Simmons' common stock is: A. 4.0%. B. 5.0%. C. 5.6%. D. 10.6%. E. 11.4%.

E

For the levered firm the equity beta is __________ the asset beta. A. greater than B. less than C. equal to D. sometimes greater than and sometimes less than E. None of the above.

a

A firm with high operating leverage has: A. low fixed costs in its production process. B. high variable costs in its production process. C. high fixed costs in its production process. D. high price per unit. E. low price per unit.

c

For a multi-product firm, if a project's beta is different from that of the overall firm, then the: A. CAPM can no longer be used. B. project should be discounted using the overall firm's beta. C. project should be discounted at a rate commensurate with its own beta. D. project should be discounted at the market rate. E. project should be discounted at the T-bill rate.

c

The use of WACC to select investments is acceptable when the: A. correlation of all new projects are equal. B. NPV is positive when discounted by the WACC. C. risk of the projects are equal to the risk of the firm. D. firm is well diversified and the unsystematic risk is negligible. E. None of the above.

c

Beta measures depend highly on the: A. direction of the market variance. B. overall cycle of the market. C. variance of the market and asset, but not their co-movement. D. covariance of the security with the market and how they are correlated. E. All of the above.

d

The beta of a security provides an: A. estimate of the market risk premium. B. estimate of the slope of the Capital Market Line. C. estimate of the slope of the Security Market Line. D. estimate of the systematic risk of the security. E. None of the above.

d

The problem of using the overall firm's beta in discounting projects of different risk is the: A. firm would accept too many high-risk projects. B. firm would reject too many low risk projects. C. firm would reject too many high-risk projects. D. firm would accept too many low risk projects. E. Both A and B.

e