Finance 450 Exam 4

The stock of Nowhere Man, Inc. had earned 78% over the last 20 years. What annually compounded rate of return did this investment earn over the last 20 years? Multiple Choice 7.93% 3.9% 78% 2.93%

Annualized return = (1+0.78)1/20 - 1 = 0.0293 Or N = 20, PV = -1, FV = 1.78, PMT = 0, I = 0.0293 2.93%

What is the arithmetic average return for a stock with annual returns of 13 percent, 9 percent, −3 percent, and 15 percent? Multiple Choice 10.90% 9.90% 8.27% 8.50%

Arithmetic Return = (.13 + .09 − .03 + .15)/4Arithmetic Return = .0850, or 8.50% 8.50%

A stock had annual returns of 7 percent, −28 percent, 13 percent, and 23 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent. Multiple Choice 3.75; 4.27 17.75; 4.27 3.75; 1.72 3.75; 17.46

Arithmetic average = (.07 − .28 + .13 + .23)/4Arithmetic average = .0375, or 3.75%Geometric return = [1.07(.72)(1.13)(1.23)].25 − 1Geometric return = .0172, or 1.72% 3.75; 1.72

Of the options listed below, which is the best measure of systematic risk? Multiple Choice The geometric average The standard deviation Beta The weighted average standard deviation

Beta

A stock has a beta of 1.75, the expected return on the market is 13 percent, and the risk-free rate is 5.2 percent. What must the expected return on this stock be? Multiple Choice 19.79% 27.95% 17.91% 18.85%

CAPM states the relationship between the risk of an asset and its expected return. CAPM is: E(Ri) = Rf + [E(RM) − Rf] × βi Substituting the values we are given, we find:E(Ri) = 0.052 + (0.13 − 0.052)(1.75)E(Ri) = 0.1885, or 18.85% 18.85%

Given the following information for Get Back, Inc. what is the WACC for Get Back Inc.? Equity: Value of equity = $30,000,000; Beta = 1.4; Market return = 15%, Risk-free rate = 5% Debt: Value of Debt = $20,000,000; Yield to maturity of debt = 6%; Tax rate = 20% Multiple Choice 13.81% 10.48% 13.32%

Cost of equity = 5 + (15-5) = 19 Cost of debt = 6 (given) Total firm value = 30,000,000+20,000,000=50,000,000 WE = 30,000,000/50,000,000 = .6 WD = 20,000,000/50,000,000 = .4 WACC = (.6)*19 + (.4)*6*.8 = 13.32 13.32%

Based on the following information, what is the standard deviation of returns? State of Economy Probability of State of Economy Rate of Return if State OccursRecession.21−.089Normal.48.104Boom.31.214 Multiple Choice 15.38% 10.74% 11.53% 13.06%

E(R) = .21(−.089) + .48(.104) + .31(.214)E(R) = .0976, or 9.76% σ2 = .21(−.089 − .0976)2 + .48(.104 − .0976)2 + .31(.214 − .0976)2σ2 = .01153 σ = .011531/2σ = .1074, or 10.74% 10.74%

Based on the following information, what is the expected return? State of Economy Probability of State of Economy Rate of Return if State OccursRecession.32−10.20%Normal.3511.70%Boom.3321.40% Multiple Choice 7.89% 11.16% 7.76% 7.63%

E(R) = .32(−.102) + .35(.117) + .33(.214)E(R) = .0789, or 7.89% 7.89%

Assume all stock prices fairly reflect all of the available information on those stocks. Which one of the following terms best defines the stock market under these conditions? Multiple Choice Evenly distributed market Riskless market Efficient capital market Zero volatility market

Efficient Capital Market

What is the geometric average return for a stock with annual returns of 18 percent, 9 percent, −5 percent, and 14 percent? Multiple Choice 12.39% 9.00% 11.39% 8.64%

Geometric Return = [(1 + .18) × (1 + .09) × (1 − .05) × (1 + .14)] ¼ − 1Geometric Return = .0864, or 8.64% 8.64%

When we compute the weighted average cost of capital (WACC), we multiply the cost of debt by (1-T) because, Multiple Choice Interest payments are subtracted from income lowering the overall cost of debt. Dividends are also subtracted from income so we should multiply them by (1-T) as well. Debt is not in the capital structure so it costs less. All of the above.

Interest payments are subtracted from income lowering the overall cost of debt.

You are aware that your neighbor, Paul, trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. Paul often comments on the huge profits he earns on these trades. Paul's trading is an example of a violation of _______ form efficiency. Multiple Choice semiweak weak strong semistrong

Markets can't be strong for efficient if Paul is earning big returns. Strong

If the beta of Revolution is 2, risk-free rate is 3.8% and the market rate of return is 15.3%, calculate the required return for Revolution assuming that the CAPM is true. Multiple Choice 7.6% 23% 27.8% 26.8%

Required return = 3.8 + 2*(15.3 - 3.8) = 26.8% 26.8%

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the cost of debt is 6.59 percent. What is the weighted average cost of capital? Multiple Choice 11.67% 11.38% 10.96% 12.05%

Since D/E = .62, We can assume that D = .62 and E 1, So A = 1.62 WACC = (1/1.62)(.163) + (.62/1.62)(.0659)(.79)WACC = .1205, or 12.05% 12.05%

Yellow Submarine, Co. has a cost of equity of 10.75 percent, a cost of debt of 5.41 percent, and a tax rate of 21 percent. The company uses only debt and equity and the company's percentage of debt in its capital structure is 35 %. What is the company's WACC? Multiple Choice 6.65% 8.88% 8.48% 10.90%

Since WD = .35, WE = 1- .35 = .65 WACC = .65(10.75%) + .35(5.41%)(1 − .21)WACC = 8.48% 8.48%

I Am The Walrus (IATW) has a weight of equity in its capital structure of 67.1%. The firm has bonds that are currently selling for $1,000. The bonds mature in 12 years, have a coupon rate of 8.5, and pay coupons annually. The firm's beta is 1.4, the risk free rate is 5%, and the market return is 9%. The tax rate is 25%. Calculate the WACC. Multiple Choice 9.909% 7.21% 8.21% 9.21%

Since WE = 0.671, WD = 1 - WE = 1- 0.671 = 0.329 The cost of equity = 5 + 1.4 * (9-5) = 10.6 Since the price of the bond is $1,000, the YTM of the bond must equal the coupon rate, so YTM = 8.5. You can also plug into the financial calculator to find YTM. 0.671*10.6 + 0.329*8.5*.75 = 9.21 9.21%

Why is risk eliminated when we combine assets into a large portfolio? Multiple Choice Assets are not perfectly correlated. Assets are perfectly negatively correlated. Assets all have correlation coefficients of 1.0. Diversification eliminates the market component of risk.

Since assets are not perfectly correlated, adding assets into a large portfolio will reduce risk. Assets are not perfectly correlated.

The risk-free rate is 4 percent and the market return is 11.3 percent. What is the required return of Blackbird, Cos. stock if the stock has a beta of 1.0 ? Multiple Choice 18.13% 11.30% 15.63% 11.67%

Since the stock has a beta of one its return will equal the market return so, the required return = .113 11.30%

In a well diversified portfolio, the type of risk that will not be eliminated is: Multiple Choice unsystematic risk firm-specific risk systematic risk standard deviation

Systematic risk is what is left after diversification systematic risk

Over the long run, the choice that will drive an investor's return is: Multiple Choice The category of asset that the investor chooses (stocks vs bonds, e.g.). The individual assets that an investor selects (IBM bonds vs. GE bonds, e.g.) The inflation rate All of the above

The category of asset that the investor chooses (stocks vs bonds, e.g.).

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient. Multiple Choice The information was expected. The news was positive. Investors do not pay attention to daily news. Investors tend to overreact.

The information was expected

The stock of Derek and the Dominos is expected to earn a return of 12.17 % next year. You know that the risk-free rate is 3 percent, the market return is 12.3 percent, and that the beta of Derek and the Dominos stock is 1.15? Given this information, which of the following is true? Multiple Choice The stock is undervalued. We need the required rate of return on the stock. The stock is overvalued. The stock is fairly valued.

The required return for the stock is = .030 + 1.15(.123 − .030) = .1370, or 13.70%. Since the required return is greater than the expected return, the stock is overvalued. stock is overvalued

Suppose a stock had an initial price of $79 per share, paid a dividend of $1.55 per share during the year, and had an ending share price of $90. Compute the percentage total return earned on the stock. Multiple Choice 16.68% 19.49% 15.89% 13.94%

The return of any asset is the increase in price, plus any dividends or cash flows, all divided by the initial price. The return of this stock is: R = [($90 − 79) + 1.55]/$79 R = 0.1589, or 15.89% 15.89%

One year ago, you purchased a stock at a price of $38.22 per share. Today, you sold the stock and realized a total loss of 11.09 percent on your investment. Your capital loss was −$4.68 per share. What was your dividend yield? Multiple Choice 1.02% 1.15% .88% .38%

Total return = Capital gain return + Dividend yield, So Dividend Yield = Total return - Capital gain return Dividend yield = −.1109 − (−$4.68/$38.22)Dividend yield = .0115, or 1.15% 1.15%

For an individual stock, ________ measures total risk, and ________ measures systematic risk. Multiple Choice beta; alpha variance; standard deviation beta; standard deviation standard deviation; beta

Total risk is measured by standard deviation, systematic risk is measured by beta standard deviation; beta

Yesterday, Inc. has 1000 bonds outstanding at a price of $950 per share. The company only uses equity and debt to fund its capital. The total value of entire company is $2,147,800 What is the capital structure weight of equity for Yesterday, Inc.? Multiple Choice 0.442 0.669 0.558 0.331

Value of debt = 1000*950 = 950,000 Value of equity = 2,147,800 - 950,000 = 1,197,800 WE = $(1,197,800/ 2,147,800)=0.558 0.558

Penny Lane has 1 million shares of common stock outstanding with a current market price per share of $22. The firm has outstanding debt with a total market value of $24,000,000. What capital structure weight would you use for debt when calculating the firm's WACC? Multiple Choice 0.478 0.572 0.522 0.622

Value of equity = 22*1,000,000 = 22,000,000 Total value = 24,000,000 + 22,000,000 = 46,000,000 WD = 24,000,000 / 46,000,000 = 0.522 0.522

A Hard Days Night (HDN) has a capital structure that is based on 45 percent debt, 5 percent preferred stock, and 50 percent common stock. The cost of debt is 6.4 percent, the cost of preferred is 8.9 percent, and the cost of common stock is 12.5 percent. The tax rate is 21 percent. What is the WACC for HDN? Multiple Choice 8.97% 9.15% 12.5% 8.525%

WACC = 0.45*6.4*.79+0.05*8.9+0.5*12.5 = 8.97 8.97%

Jerry Jeff, Inc. has 16,700 shares of common stock outstanding at a price per share of $83 and the rate of return on the stock is 11.93 percent. The value of Jerry Jeff's debt is $717,120 and the required rate of return on the debt is 6.29 percent. What is the Jerry Jeff's WACC if the tax rate is 21 percent? Multiple Choice 8.83% 8.67% 9.56% 10.01%

WACC = 11.93%($1,386,100/$2,103,220) + 6.29%($717,120/$2,103,220)(1 − .21)WACC = 9.56% 9.56%

Fleetwood Mac (FM) uses only debt and equity in its capital structure. The value of FM's debt is $8,650,000 and the value of FM's equity is $12,800,000. FM's bonds are currently selling for $950, mature in 12 years, and have an annual coupon rate of 8%. FM's beta is 1.7, the risk free rate is 6%, and the market return is 14%. FM has a tax rate of 25%. What is FM's WACC? Multiple Choice 19.6% 10.77% 14.92% 14.32%

WE = 12,800,000 / (12,800,000+8,650,000) = 0.597 WD = 8,650,000/(12,800,000+8,650,000) = 0.403 RD; Input N=12, PMT=80, FV=1000, PV=-950: Solve I/Y = 8.687 = RD RE = 6 + 1.7*(14-6) = 19.6 WACC = 0.597*19.6 + 0.403*8.687*.75 = 14.323% 14.325%