Pre-test Chapters 8-12

A) 0.93 B) 0.98 C) 1.03 D) 1.08 E) *1.10* Beta (portfolio)= 50%*0.8+50%*1.4=1.10

Tom Skinner has $50,000 invested in a stock with a beta of 0.8 and another $50,000 invested in a stock with a beta of 1.4. These are the only two investments in his portfolio. What is his portfolio's beta?

a. *3.2%* b. 3.7% c. 4.0% d. 4.7% e. 31.3% R=D/P0=$4/$125

Topstone Industries' preferred stock pays an annual dividend of $4.00 per share. When issued, the shares sold for their par value of $100 per share. What is the cost of preferred stock if the current price is $125 per share?

a. 6.0% b. 9.2% c. 7.2% d. *7.7%* e. 8.4% R=5%+0.3*(14%-5%)=7.7%

What is the expected return on asset A if it has a beta of 0.3, the expected market return is 14%, and the risk-free rate is 5%?

a. 0.25 b. 0.50 c. *0.75* d. 1.00 e. 1.25 beta (portfolio)=25%*1+25%*2+50%*0=0.75

What is the portfolio beta if 25% of your funds are invested in the market portfolio, 25% in an asset with beta of 2, and the remainder in a risk-free asset?

a. Long-term corporate bonds. b. US Treasury bills. c. Long-term government bonds. d. Common stock of the largest companies in the United States. e. *Common stock of the smallest companies listed on NYSE.*

Which of the following assets likely has the highest level of risk?

a. Net present value profiling. b. Operational ambiguity. c. *Mutually exclusive investment decisions* d. Issues of scale. e. Multiple rates of return.

A situation in which taking one investment prevents the taking of another is called:

a. Salvage value expense. b. Net working capital expense. c. Sunk cost. d. *Opportunity cost.* e. Erosion cost

A valuable investment given up if an alternative investment is chosen is a(n):

A) *6.6%* B) 6.8% C) 5.8% D) 7.0% E) 7.5% Portfolio beta= (50000/75000)*1.5+(25000/75000)*0.9=1.3 Portfolio Return= 4%+1.3*2%=6.6%

An investor is forming a portfolio by investing $50,000 in stock A that has a beta of 1.50, and $25,000 in stock B that has a beta of 0.90. The market risk premium is equal to 2% and Treasury bonds have a yield of 4%. What is the required rate of return on the investor's portfolio?

a. $700,000 b. $310,000 c. $201,500 d. *$901,500* e. None of the above Annual depreciation: $2,100,000/3=$700,000 OCF=($2,150,000-$1,140,000-$700,000)*(1-35%)+$700,000

Cochrane, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $2.1 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,150,000 in annual sales, with costs of $1,140,000. If the tax rate is 35 percent, what is the OCF for this project?

a. $1,205.35 b. $1,103.94 c. *$ 1.23* d. $ 567.07 e. $1,218.12

For a project with an initial investment of $40,000 and cash inflows of $11,000 a year for 5 years, calculate NPV given a required return of 11.65%.

a. The IRR is equal to the firm's required rate of return. b. *The IRR is greater than the firm's required rate of return.* c. The payback period is longer than the firm's required cutoff point. d. The IRR is less than the firm's required rate of return. The IRR is zero

For a project with conventional cash flows, if NPV is greater than zero, then:

a. 9.5% b. 10.0% c. 10.8% d. 11.6% e. *12.0%* C=6.5M*14=91M P=10M D=25,000*900=22.5M V=C+P+D=123.5M WACC=(91/123.5)*14%+(10/123.5)*10%+(22.5/123.5)*7.25%*(1-34%)

JLP Industries has 6.5 million shares of common stock outstanding with a market price of $14.00 per share. The company also has outstanding preferred stock with a market value of $10 million, and 25,000 bonds outstanding, each with face value $1,000 and selling at 90% of par value. The cost of equity is 14%, the cost of preferred is 10%, and the cost of debt is 7.25%. If JLP's tax rate is 34%, what is the WACC?

a. Benefit-cost analysis b. Erosion planning c. Opportunity cost analysis d. *Sensitivity analysis* e. Scenario analysis

Mark is analyzing a proposed project to determine how changes in the variable costs per unit would affect the project's net present value. What type of analysis is Mark conducting?

A) 14.00% B) 15.00% C) *16.00%* D) 17.00% E) 18.00% 13%=7%+beta*4% Beta=1.5 R=7%+1.5*6%=16%

Niendorf Corporation's stock has a required return of 13.00%, the risk-free rate is 7.00%, and the market risk premium is 4.00%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases to 6.00%. What is Niendorf's new required return?

a. 0.157 b. *0.314* c. 0.686 d. 0.739 e. 0.843 E=10.4M*$12=$124.8M D=56M*102%=$57.12M Wd=D/(D+E)=$57.12/(124.8+57.12)

Suppose a firm has 10.4 million shares of common stock outstanding with a par value of $1.00 per share. The current market price per share is $12.00. The firm has outstanding debt with a par value of $56.0 million selling at 102% of par. What capital structure weight would you use for debt when calculating the firm's WACC?

a. *Risk premium.* b. Return premium. c. Excess return. d. Average return. e. Variance.

The excess return required on a risky asset over that earned on a risk-free asset is called:

a. 6.75% b. *7.35%* c. 7.84% d. 8.60% e. 9.45% PV=-1,045 FV=1,000 PMT=80 N=10 CPT YTM

The long-term debt of Topstone Industries is currently selling for 104.50% of its face value. The issue matures in 10 years and pays an annual coupon of 8%. What is the cost of debt (before tax)?

a. Portfolio return. b. *Portfolio weight.* c. Portfolio risk. d. Rate of return. e. Investment value.

The percentage of a portfolio's total value invested in a particular asset is called that asset's:

a. *An investment is acceptable if its PI is greater than one.* b. An investment is acceptable if its PI is less than one. c. An investment is acceptable if its PI is greater than the internal rate of return (IRR). d. An investment is acceptable if its PI is less than the net present value (NPV).

The profitability index (PI) rule can be best stated as:

a. *Adjusting the discount rate upward if the project is judged to have above average risk.* b. Adjusting the discount rate downward if the project is judged to have above average risk. c. Reducing the NPV by 10% for risky projects. d. Picking a risk factor equal to the average discount rate. e. Ignoring it because project risk cannot be measured accurately.

The relative risk of a proposed project is best accounted for by

a. The Wall Street Journal reported that Gross Domestic Profit declined 4.9% during the latest quarter. b. Today the dollar declined significantly in value against the Euro. c. The Federal Reserve just made an unexpected announcement of a 0.5% increase in the Federal Funds rate. d. *The Chief Financial Officer of a widely known public corporation was charged by the Securities & Exchange Commission with manipulating the firm's financial statements.*

Which of the following events would be classified as an example of diversifiable risk?

a. Long-term debt. b. Common stock. c. Retained earnings. d. *Accounts payable.* e. Preferred stock.

Which of the following is not a capital component when calculating the weighted average cost of capital (WACC)?

a. *Newly issued common stock.* b. Long-term bonds. c. Preferred stock. d. Short-term notes payable. e. Retained earnings.

Which of the following sources of capital is generally the most expensive for an average corporation?

a. 10.00% b. 16.83% c. 19.12% d. *23.42%* e. 24.56%

Woodgate Inc. is considering a project with the following after-tax operating cash flows (in millions of dollars): Year Cash Flow 0 -$300 1 125 2 75 3 200 4 100 The project has a discount rate of 10%. What is the project's IRR?

a. 2.00 years b. 2.50 years c. *2.75 years* d. 2.83 years e. 3.00 years

Woodgate Inc. is considering a project with the following cash flows (in millions of dollars): Year Cash Flow 0 -$300 1 125 2 100 3 100 4 100 What is the project's payback period?

a. I only b. I and II only c. *I and III only* d. II and III only e. I, II, and III

You are advising a friend who is attempting to decide whether or not to drop one of the courses they are currently enrolled in. If they drop, they will forfeit the money spent on tuition. Which of the following regarding the drop decision is consistent with capital budgeting principles? I. Remaining in the class means you must give up your part-time job. II. The tuition cost for the class was outrageous, $1,000 per credit hour. III. If you drop the class, you can sell the textbook now for $30 at the bookstore.

a. A has a lower variance than B. b. A has a lower standard deviation than B. c. A has a higher inflation premium than B. d. *A has a higher return volatility than B.* e. A must be one of the 500 largest stocks in the United States, while B must be one of the smallest firms listed on the NYSE.

You are considering two investments. You note that the return on A tends to vary quite widely from its average, definitely more so than does B. Based on this, you believe that:

a. *$0* b. $20,000 c. $19,800 d. $40,200 Depreciation in year 1= $60,000*33%=19,800 NCS= End(Net fixed Asset)-Beg(Net fixed Asset)+Depreciation= ($60,000-$19,800)-$60,000+$19,800=0

You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck's basic price is $60,000. The truck falls in the MACRS 3-year class, and it will be sold after three years for $20,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. Use of the truck will require an increase in net working capital (spare parts inventory) of $2,000. What is the net capital spending in Year 1?

a. $1,010 b. $3,510 c. $5,010 d. *$5,490* e. $6,990 Annual depreciation: ($12,000-$2,000)/4=$2,500 Book value at the end of the third year= $12,000-($2,500*3)=$4,500 After-tax salvage value= $6,000-[($6,000-$4,500)*34%]

You purchase a machine for $12,000, depreciated straight-line to a book value of $2,000 over its 4 year life. If the machine is sold at the end of the third year for $6,000, what are the aftertax proceeds from the sale, assuming your tax rate is 34%?

a. $ 2.66 b. $10.66 c. $72.34 d. $77.34 e. *$82.66*

You purchased a bond on January 1, 2017 for $839.67. The bond has a $1000 face value, an 8% annual coupon, and can be sold for $842.33 on December 31, 2017. What is your total dollar return for the year?