strictly financial

The outstanding bonds of Harden Fitness are priced at $1,014.66 and mature in 5 years. These bonds have a face value of $1,000, a coupon rate of 4.5 percent, and pay interest semiannually. The tax rate is 21 percent. What is the aftertax cost of debt?

$1,014.66 = [(.045)($1,000)/2][(1 - {1/[1 + (r/2)5(2)})/(r/2)] + $1,000/[1 + (r/2)]5(2) Using trial and error, a financial calculator, or a computer: r = 4.17% Aftertax cost of debt = 4.17%(1 - .21) Aftertax cost of debt = 3.30%

The average annual return on small-company stocks was about _____ percentage points greater than the average annual return on large-company stocks over the period 1926-2019.

4

Suppose a stock had an initial price of $30 per share, paid a dividend of $5 per share during the year, and had an ending share price of $33.40. What was the capital gains yield?

Capital gains yield = ($33.40 - 30)/$30 Capital gains yield = .113, or 11.3%

An investment project costs $10,200 and has annual cash flows of $6,500 for 3 years. If the discount rate is 13 percent, what is the discounted payback period?

DPB = 1 + ($10,200 - $6,500/1.13)/($6,500/1.132) DPB = 1.87 years

Which one of the following methods of project analysis is defined as computing the value of a project based on the present value of the project's anticipated cash flows?

Discounted cash flow valuation

You own a portfolio that has $1,720 invested in Stock A and $3,470 invested in Stock B. The expected returns on these stocks are 13.7 percent and 8.0 percent, respectively. What is the expected return on the portfolio?

E(Rp) = [$1,720/($1,720 + 3,470)](.137) + [$3,470/($1,720 + 3,470)](.08) E(Rp) = .0989, or 9.89%

When computing the adjusted cash flow from assets, the tax amount is calculated as:

EBIT(TC)

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?

Efficient capital market

Which of the following statements is true of a portfolio's standard deviation?

It can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

The market has an expected rate of return of 6.50 percent. A long-term government bond is expected to yield 3.4 percent and a U.S. Treasury bill is expected to yield 2.25 percent. The inflation rate is 2.15 percent. What is the market risk premium?

Market risk premium = 6.50% - 2.25% Market risk premium = 4.25%

A project has cash flows of -$343,200, $56,700, $138,500, and $245,100 for Years 0 to 3, respectively. The required rate of return is 10.5 percent. Based on the internal rate of return of _____ percent for this project, you should _____ the project.

NPV = 0 = -$343,200 + $56,700/(1 + IRR) + $138,500/(1 + IRR)2 + $245,100/(1 + IRR)3 IRR = .1093, or 10.93% ACCEPT

A project has cash flows of -$108,000, $52,800, $53,200, and $83,100 for Years 0 to 3, respectively. The required payback period is two years. Based on the payback period of _____ years for this project, you should _____ the project.

Payback = 2 + ($108,000 - 52,800 - 53,200)/$83,100 Payback = 2.02 years

It will cost $15,000 to acquire a used food truck that is expected to produce cash inflows of $8,500 per year for five years. After the five years, the truck is expected to be worthless. What is the payback period?

Payback period = $15,000/$8,500 Payback period = 1.8 years

You own the following portfolio of stocks. What is the portfolio weight of Stock C? Stock Number of Shares Price per Share A 650 $15.82 B 320 $11.09 C 400 $39.80 D 100 $7.60

Portfolio weightC = [400($39.80)]/[650($15.82) + 320($11.09) + 400($39.80) + 100($7.60)] Portfolio weightC = .5218, or 52.18%

The Dry Well has 6.85 percent preferred stock outstanding with a market value per share of $79, a stated value of $100 per share, and a book value per share of $29. What is the cost of preferred stock?

RP = .0685($100)/$79 RP = .0867, or 8.67%

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2019?

U.S. Treasury bills

With respect to unexpected returns, which one of the following statements is accurate?

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long term.

A project's average net income divided by its average book value is referred to as the project's average:

accounting return.

When utilizing the capital asset pricing model approach to value equity, the outcome:

assumes the reward-to-risk ratio is constant.

Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the:

cost of debt

A firm's aftertax cost of debt will increase if there is a(n):

decrease in the market rate of interest.

Individual investors who continually monitor the financial markets seeking mispriced securities:

make the markets increasingly more efficient.

Rafia owns stocks of 15 different companies. Together, the stocks have a value of $78,640. Twelve percent of that total value is from one company, Gambrell & Valdez. The twelve percent figure is called a(n):

portfolio weight.

Assume a manager determines the cost of capital for a specific project based on the cost of capital at another firm with a line of business that is similar to the project. Accordingly, the manager is using the ________ approach.

pure play

The excess return is computed as the:

return on a risky security minus the risk-free rate.

To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return.

risk-free rate

Applying the discounted payback decision rule to all projects may cause:

some positive net present value projects to be rejected.

A project has a net present value of zero. Given this information:

the project's cash inflows equal its cash outflows in current dollar terms

An investor who owns a well-diversified portfolio would consider ________ to be irrelevant.

unsystematic risk

Flotation costs for a levered firm should be:

weighted and included in the initial cash flow

A stock had annual returns of 5.5 percent, -12 percent, and 15.5 percent for the past three years, respectively. What is the standard deviation of returns for this stock?

Average return = (.055 - .12 + .155)/3 Average return = .03, or 3% s = {[1/(3 - 1)][(.055 - .03)2 + (-.12 - .03)2 + (.155 - .03)2]}.5 s = .1392, or 13.92%

The rate of return on the common stock of Kang Distribution is expected to be 13.5 percent in a boom economy, 8 percent in a normal economy, and only 2.5 percent in a recessionary economy. The probabilities of these economic states are 11 percent for a boom and 26 percent for a recession. What is the variance of the returns on this common stock?

E(r) = .11(.135) + .63(.08) + .26(.025) E(r) = .0718, or 7.18% 2 = .11(.135 - .0718)2 + .63(.08 - .0718)2 + .26(.025 - .0718)2 2 = .001051

________ measures total risk, and ________ measures systematic risk.

Standard deviation; beta

Thornton Homes has multiple divisions which operate as separate lines of business and face risks unique to those lines. The firm uses its overall WACC as the discount rate to evaluate all proposed projects. Accordingly, each division within the firm will tend to:

avoid risky projects so it can receive more project funding.

The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the:

discounted payback period.

Suppose ALK Company needs $13.8 million to build a new assembly line. The target debt-equity ratio is .48. The flotation cost for new equity is 9.6 percent, but the floatation cost for debt is only 5.1 percent. What is the true cost of building the new assembly line after taking flotation costs into account?

fA = (1/1.48)(.096) + (.48/1.48)(.051) fA = .0814 Amount raised = $13,800,000/(1 - .0814) Amount raised = $15,022,949

A strength of the average accounting return (AAR) method of project analysis is the fact that AAR:

is easy to calculate.

The slope of the security market line is the:

market risk premium.

When calculating the expected rate of return on a stock portfolio using a weighted average, the weights are based on the:

market value of the investment in each stock.

A stock has annual returns of 5 percent, 21 percent, -12 percent, 7 percent, and 6 percent for the past five years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent.

Arithmetic average = (.05 + .21 - .12 + .07 + .06)/5 Arithmetic average = .054, or 5.4% Geometric return = [1.05(1.21)(.88)(1.07)(1.06)].20 - 1 Geometric return = .0486, or 4.86%

Corrinne purchased a stock for $63.80 per share, received a dividend of $2.68 per share, and sold the shares for $59.74 each. During the time he owned the stock, inflation averaged 2.8 percent. What was the approximate real rate of return on this investment?

Nominal return = ($59.74 - 63.80 + 2.68)/$63.80 Nominal return = -.0216, or -2.16% Approximate real return = -.0216 - .028 Approximate real return = -.0496, or -4.96%

Your portfolio has a beta of 1.24. The portfolio consists of 6 percent U.S. Treasury bills, 40 percent Stock A, and 54 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B?

Portfolio = 1.24 = (.06)(0) + (.40)(1) + (.54B) B = 1.56 The beta of a risk-free asset is zero. The beta of the market is 1.

Over a 25-year period an asset had an arithmetic return of 13.1 percent and a geometric return of 12.6 percent. Using Blume's formula, what is your best estimate of the future annual returns over the next 10 years?

R(10) = [(10 - 1)/(25 - 1)](.126) + [(25 - 10)/(25 - 1)](.131) R(10) = .1291 or 12.91%

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 per share. The common stock has a beta of 1.32 and sells for $41 per share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital?

RE = .022 + 1.32(.106 - .022) = .13288, or 13.288% RP = (.055)($100)/$64 = .08594, or 8.594% E = 75,000($41) = $3,075,000 P = 48,000($64) = $3,072,000 D = 6,500(.965)($1,000) = $6,272,500 V = $3,075,000 + 3,072,000 + 6,272,500 V = $12,419,500 WACC = ($3,075,000/$12,419,500)(.13288) + ($3,072,000/$12,419,500)(.08594) + ($6,272,500/$12,419,500)(.067)(1 - .21) WACC = .0809, or 8.09%

Silo Mills is an all-equity financed firm that has a beta of 1.18 and a cost of equity of 12.2 percent. The risk-free rate of return is 2.9 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of six years. What discount rate should be assigned to this project?

RE = .122 = .029 + 1.18(MRP) MRP = .0788 RProjec = .029 + 1.03(.0788) RProjec = .1102, or 11.02%

You have a $15,000 portfolio which is invested in Stocks A and B, and a risk-free asset. $6,000 is invested in Stock A. Stock A has a beta of 1.63 and Stock B has a beta of .95. How much needs to be invested in Stock B if you want a portfolio beta of 1.10?

bPortfolio = 1.10 = ($6,000/$15,000)(1.63) + (x/$15,000)(.95) + [($15,000 - 6,000 - x)/$15,000](0) x = $7,073.68

A project has an initial cost of $52,700 and a market value of $61,800. What is the difference between these two values called?

Net present value

A project has an initial cost of $31,300 and a three-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected net income from the project is $1,750, $2,100, and $1,700 per year for the next three years, respectively. What is the average accounting return?

AAR = [($1,750 + 2,100 + 1,700)/3]/[($31,300 + 0)/2] AAR = .1182, or 11.82%

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.

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

An investor wants to reduce the unsystematic risk in her portfolio. Which of the following actions is least likely to do so?

Reducing the number of stocks held in her stock portfolio

A stock had returns of 14 percent, 13 percent, -10 percent, and 7 percent for the past four years. Which one of the following best describes the probability that this stock will lose no more than 10 percent in any one year?

Average return = (.14 + .13 - .10 + .07)/4 Average return = .06, or 6% s = {[1/(4 - 1)][(.14 - .06)2 + (.13 - .06)2 + (-.10 - .06)2 + (.07 - .06)2]}.5 s = .1111, or 11.11% Lower bound of 68 percent range = .06 - .1111 Lower bound of 68 percent range = -.0511, or -5.11% Lower bound of 95 percent range = .06 - 2(.1111) Lower bound of 95 percent range = -.1621, or -16.21% The probability of losing more than 10 percent in any given year is between 2.5 and 16 percent. Thus, the probability of NOT losing more than 10 percent is between 84 and 97.5 percent.