Fin 221 Midterm 2
what is stock expected price __ years from now
(current price)(1+g)^years
what would the cost of preferred stock.. after flotation costs?
(par value x dividend yield) / price
current stock price
*Rrf + ( Rm - Rrf)(beta) *(current dividend)(1+growth rate) = expected dividend *expected dividend/(required return - growth rate)
year 0 cash flow
*selling value now - book value = gain/loss *gain/loss * tax = tax expense *selling price - tax expense = net proceed *purchase price - net proceed
What is the projects discounted payback
*year 1 amount/ (1 + WACC) *Year 0 - Year 1 = # payed back *Year 2 amount/(1+WACC)^2 1 + (amount payed back / year 2 amount)
MIRR
0 = CF0 1. find NPV 2. NPV becomes PV (negative); find FV 3. Use original CF0 as PV; calculate I
calculate required rate of return
1. add investments 2. find weight (percentage) that each investment is for the total investment 3. multiply weight by beta 4. find sum = portfolio beta 5. plug new portfolio beta into r = Rrf + b(Rpm)
find WACC given bulletpointed info
1. find I (YTM) 2. calculate rate of return 3. [weight of debt * cost of debt * (1-t)] + (weight of equity * cost of equity)
EAA
1. find NPV 2. NPV becomes PV; find pmt PMT = EAA *choose what has a higher EAA
Crossover rate
1. find differences in cash flows 2. set as cash flows 3. cpt irr
if firms required return is __ what is its current stock price
1. find dividends compounding (dividends)(1+g) 2. P0 = dividend/(1+rx)^year + .... + [(dividend/(rs - g) x 1/(1+rs)^year-1
bonds nominal coupon interest rate
1. find pmt 2. find what percentage pmt is of par value
NPV (with a ? as the first cash flow)
1. find the npc of all the cash flows with first IRR as I 2. this npv becomes cf0 (negative) 3. find npc of all cash flows with irr as cost of capital
intrinsic value per share of common stock
1. value of the firm = (current free cash flow)(1+g)/WACC-g 2. value of equity = value of firm - value of long term debt 3. price per share = value of equity / number of shares
Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? Question 31 options: A) A project's NPV increases as the WACC declines. B) A project's MIRR is unaffected by changes in the WACC. C) A project's regular payback increases as the WACC declines. D) A project's discounted payback increases as the WACC declines. E) A project's IRR increases as the WACC declines.
A) A project's NPV increases as the WACC declines.
variable growth model
D1/(1+rs) + D2(1+rs)^2 + D3+P3/(1+rs)^3 P3=D3(1+g)/(rs-g)
Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT? A. Over the next year, Bond 8's price is expected to decrease, Bond 10's price is expected to stay the same, and Bond 12's price is expected to increase. B. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year. C. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity. D. Bond 8's current yield will increase each year. E. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.
E
By how much did the change in the WACC affect the project's forecasted NPV?
NPV (old) + NPV (new)
expected return equation
R = Rrf + (Rm-Rrf)beta
A major disadvantage of the discounted payback period is that it A. Ignores cash flows beyond the payback period. B. Is useless as a risk and liquidity indicator. C. Does not directly account for the time value of money. D. All of the statements above are correct.
a
If a company uses the same cost of capital for evaluating all projects, which of the following results is likely? A. Rejecting good, low-risk projects. B. Accepting no projects. C. Rejecting good, high-risk projects. D. Accepting poor, average-risk projects.
a
LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept? a. Project B, which is of below-average risk and has a return of 8.5%. b. Project C, which is of above-average risk and has a return of 11%. c. Project A, which is of average risk and has a return of 9%. d. None of the projects should be accepted. e. All of the projects should be accepted.
a
The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, , is positive. Which of the following statements is CORRECT? A. If Stock A's required return is 11%, then the market risk premium is 5%. B. If Stock B's required return is 11%, then the market risk premium is 5%. C. Stock B's required rate of return is twice that of Stock A. D. If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. E. If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's.
a
Which of the following measures increases when the cost of capital increases? A. Modified Internal Rate of Return B. Net Present V alue C. Internal Rate of Return D. Payback Period
a
Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project? a. The new project is expected to reduce sales of one of the company's existing products by 5%. b. Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost. c. The company has spent and expensed $1 million on R&D associated with the new project. d. The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project. e. The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.
a
what is the nominal annual rate of return
annual dividend / price
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 lower dividend growth rate. C. The two stocks must have the same dividend yield. D. The two stocks must have the same dividend growth rate. E. If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
b
Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project? a. Changes in net operating working capital. b. Shipping and installation costs for machinery acquired. c. Cannibalization effects. d. Opportunity costs. e. Sunk costs that have been expensed for tax purposes.
b
terminal cash flow
base price + shipping/installation = total amount *find depreciation amounts for total price)* *add depreciation amounts) total amount - depreciation amounts = book value *salvage value - book value x tax rate =net cash flow *salvage value - net cash flow + net working capital
Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? A. A project's MIRR is unaffected by changes in the WACC. B. A project's IRR increases as the WACC declines. C. A project's NPV increases as the WACC declines. D. A project's discounted payback increases as the WACC declines. E. A project's regular payback increases as the WACC declines.
c
Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price? A. A 3-year bond with a 10% coupon. B. An 8-year bond with a 9% coupon. C. A 10-year zero coupon bond. D. A 10-year bond with a 10% coupon. E. A 1-year bond with a 15% coupon.
c
Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? A. A Division A project with a 9% return. B. A Division B project with a 12% return. C. A Division A project with an 11% return. D. A Division B project with an 11% return. E. A Division B project with a 13% return.
c
Smith Brothers has no retained earnings. The company uses the CAPM to calculate the cost of equity capital. The company's capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company's WACC? A. An increase in the flotation costs associated with issuing preferred stock. B. An increase in the company's beta. C. A decrease in expected inflation. D. An increase in the market risk premium. E. An increase in the flotation costs associated with issuing new common stock.
c
Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting? a. Long-term debt. b. Common stock. c. Accounts payable. d. Preferred stock. e. All of the above are considered capital components for WACC and capital budgeting purposes.
c
Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT? a. Project D is probably larger in scale than Project C. b. The crossover rate between the two projects is below 12%. c. Project D probably has a higher IRR. d. Project C probably has a faster payback. e. Project C probably has a higher IRR
c. Project D probably has a higher IRR.
A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? Please explain how also. Select one: a. The bond's coupon rate exceeds its current yield. b. The bond's current yield exceeds its yield to maturity. c. The bond's yield to maturity is greater than its coupon rate. Correct d. The bond's current yield is equal to its coupon rate. e. If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.
c. The bond's yield to maturity is greater than its coupon rate.
which of the following (all else constant) would cause an increase in a company wacc a. lower stock beta b. retaining a higher portion of the companies earnings c. a lower marginal tax rate d. a lower risk-free rate e. a lower market risk premium
c. a lower marginal tax rate
you are considering buying a stock whose expected return lies below the security market line. what should you do a. don't buy the stock only if its beta is less than 1 b. buy the stock only if its beta is greater than 1 c. don't buy the stock d. buy. the stock
c. don't buy the stock
Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT? a. portfolio p has an expected return of 12 percent b. portfolio p has a beta of 1.4 c. portfolio p has a standard deviation of 25 percent d. a and b e. all
c??
wacc with flotation costs
cost of equity = d1/P0(1+f) + g cost of debt = (yield on bonds)(1 - tax rate) [weight of debt * cost of debt * (1-t)] + (weight of equity * cost of equity)
What method should a firm use in order to make a decision between two mutually exclusive projects with unequal lives. A. Modified internal rate of return B. Discounted payback period C. Internal rate of return D. Replacement chain approach
d
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? A. Beta; beta. B. Beta; variance. C. Standard deviation; correlation coefficient. D. Coefficient of variation; beta. E. V ariance; correlation coefficient.
d
Which of the following should be excluded from the cash flows for a potential new project? A. Depreciation of project's cost B. Externalitites C. Cannibalization D. Interest expense E. Opportunity costs
d
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC. b. If a project's IRR is greater than the WACC, then its NPV must be negative. c. To find a project's IRR, we must find a discount rate that is equal to the WACC. d. To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs. e. A project's regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
d. To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
what is company's Waco
d1 / (p0+g) = cost of equity [weight of debt * cost of debt * (1-t)] + (weight of equity * cost of equity)
During the coming year, the market risk premium (rM ? rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT? A The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. B The required return on all stocks will remain unchanged. C The required return will fall for all stocks, but it will fall more for stocks with higher betas. D The required return for all stocks will fall by the same amount. E The required return will fall for all stocks, but it will fall less for stocks with higher betas.
e
Project A and Project B are mutually exclusive projects with equal risk. Project A has an internal rate of return of 12 percent, while Project B has an internal rate of return of 15 percent. The two projects have the same net present value when the cost of capital is 7 percent. (In other words, the crossover rate is 7 percent.) Assume each project has an initial cash outflow followed by a series of inflows. Which of the following statements is most correct? A. If the cost of capital is 10 percent, each project will have a positive net present value. B. If the cost of capital is 6 percent, Project B has a higher net present value than Project A. C. If the cost of capital is 13 percent, Project B has a higher net present value than Project A. D. Statements A) and B) are correct. E. Statements A) and C) are correct.
e
Project X's IRR is 19% and Project Y's IRR is 17%. has constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT? A. If the WACC is 18%, Project Y will have the higher NPV. B. Project X is larger in the sense that it has the higher initial cost. C. The crossover rate must be less than 10%. D. If the WACC is 8%, Project X will have the higher NPV. E. The crossover rate must be greater than 10%.
e
A firm is considering a new project whose risk is greater than the risk of the firm's average project, based on all methods for assessing risk. In evaluating this project, it would be reasonable for management to do which of the following? a)Increase the estimated IRR of the project to reflect its greater risk. b)Increase the estimated NPV of the project to reflect its greater risk. c)Reject the project, since its acceptance would increase the firm's risk. d)Ignore the risk differential if the project would amount to only a small fraction of the firm's total assets. e)Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk
e)Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk
You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and $100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRr of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation is best for the company and least likely to get you in trouble with either the CFO or the president? a. You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC. b. You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC. c. You should recommen that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted. d. You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, onoe of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted. e. You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted.
e. You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted.
which of the following statements is correct? assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows a. if a projects err is greater than its wacc, then the mire will be greater than the irr b. to find a projects mirror, we compound cash inflows at the irr and then discount the terminal value back to t=0 at the wacc c. a projects mirrored is always less than its regular irr d. a projects mirrored is always greater than its regular irr e. if a projects irr is greater than its wacc, then the mirrored will be less than the irr
e. if a projects irr is greater than its wacc, then the mirrored will be less than the irr
What is the maximum amount of new financing that the company can raise without selling new common stock?
income x (1 - tax rate) / ( % common equity)
What is the current market value of the firm's debt?
long-term debt/par value = amount of stocks find pv pv x amount of stocks
after tax salvage value
original - depreciation = book value salvaged value - (sv - bv)(tax)
coefficient of variation
probability * expected return sum of this = expected return on portfolio (probability)(expected return - expected portfolio return)^2 + ... = variance (variance)^1/2 = standard deviation standard deviation/expected return on portfolio = c of v
* year 1 cash flow
sales - operating costs - depreciation amount (times depreciation) x (1-tax rate) + depreciation amount
