FIN 310 exam 2 set 3

21. Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital? A. Decrease in the book value of a firm's equity B. Decrease in a firm's tax rate C. Increase in the market value of the firm's common stock D. Increase in the market risk premium E. Increase in the firm's beta

C. Increase in the market value of the firm's common stock

2. A portfolio is: A. a single risky security. B. any security that is equally as risky as the overall market. C. any new issue of stock. D. a group of assets held by an investor. E. an investment in a risk-free security.

D. a group of assets held by an investor.

19. The cost of preferred stock: A. increases when a firm's tax rate decreases. B. is constant over time. C. is unaffected by changes in the market price of the stock. D. is equal to the preferred stock's dividend yield. E. increases as the price of the stock increases.

D. is equal to the preferred stock's dividend yield.

2. Which of the following is the least broad-based measure of stock prices? a. Nasdaq market index b. Dow Jones industrial average c. S&P 500 stock index d. Russell 3000

a. Nasdaq market index

1. The Standard & Poor's 500 stock index illustrates a. a value-weighted index b. a simple average c. a geometric index d. an exponential index

a. a value-weighted index

7. The Russell 2000 index a. combines 2000 small company stocks and bonds b. uses the 2000 largest Nasdaq stocks c. is a broad measure of listed and Nasdaq stocks d. is a broad-based measure of bonds

a. combines 2000 small company stocks and bonds

1. Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate? A. Expected return B. Real return C. Market rate D. Systematic return E. Risk premium

A. Expected return

4. Systematic risk is defined as: A. any risk that affects a large number of assets. B. the total risk of an individual security. C. diversifiable risk. D. asset-specific risk. E. the risk unique to a firm's management.

A. any risk that affects a large number of assets.

20. Which one of the following is the best example of unsystematic risk? A. Inflation exceeding market expectations B. A warehouse fire C. Decrease in corporate tax rates D. Decrease in the value of the dollar E. Increase in consumer spending

B. A warehouse fire

21. Which one of these represents systematic risk? A. Major layoff by a regional manufacturer of power boats B. Increase in consumption created by a reduction in personal tax rates C. Surprise firing of a firm's chief financial officer D. Closure of a major retail chain of stores E. Product recall by one manufacturer

B. Increase in consumption created by a reduction in personal tax rates

17. Which one of the following will decrease the after-tax cost of debt for a firm? A. Decrease in the firm's beta B. Increase in tax rates C. Increase in the risk-free rate of return D. Decrease in the market price of the debt E. Increase in a bond's yield to maturity

B. Increase in tax rates

20. Which statement is true? A. An increase in the market value of preferred stock will increase a firm's weighted average cost of capital. B. The cost of preferred stock is unaffected by the issuer's tax rate. C. Preferred stock is generally the cheapest source of capital for a firm. D. The cost of preferred stock remains constant from year to year. E. Preferred stock is valued using the capital asset pricing model.

B. The cost of preferred stock is unaffected by the issuer's tax rate.

8. The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is measured by the: A. squared deviation. B. beta coefficient. C. standard deviation. D. mean. E. variance.

B. beta coefficient.

2. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the: A. pure play cost. B. cost of debt. C. weighted average cost of capital. D. subjective cost. E. cost of equity.

B. cost of debt.

3. The weighted average cost of capital is defined as the weighted average of a firm's: A. return on all of its investments. B. cost of equity, cost of preferred, and its after-tax cost of debt. C. pretax cost of debt and its preferred and common equity securities. D. bond coupon rates. E. common and preferred stock.

B. cost of equity, cost of preferred, and its after-tax cost of debt.

10. The slope of the security market line represents the: A. risk-free rate. B. market risk premium. C. beta coefficient. D. risk premium on an individual asset. E. market rate of return.

B. market risk premium.

18. All else constant, an increase in a firm's cost of debt: A. could be caused by an increase in the firm's tax rate. B. will result in an increase in the firm's cost of capital. C. will lower the firm's weighted average cost of capital. D. will lower the firm's cost of equity. E. will increase the firm's capital structure weight of debt.

B. will result in an increase in the firm's cost of capital.

6. Which term best refers to the practice of investing in a variety of diverse assets as a means of reducing risk? A. Systematic B. Unsystematic C. Diversification D. Security market line E. Capital asset pricing model

C. Diversification

3. Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent? A. Portfolio variance B. Portfolio standard deviation C. Portfolio weight D. Portfolio expected return E. Portfolio beta

C. Portfolio weight

8. Which one of the following statements is correct related to the dividend growth model approach to computing the cost of equity? A. The rate of growth must exceed the required rate of return. B. The rate of return must be adjusted for taxes. C. The annual dividend used in the computation must be for Year 1 if you are Time 0's stock price to compute the return. D. The cost of equity is equal to the return on the stock plus the risk-free rate. E. The cost of equity is equal to the return on the stock multiplied by the stock's beta.

C. The annual dividend used in the computation must be for Year 1 if you are Time 0's stock price to compute the return.

15. An increase in a levered firm's tax rate will: A. decrease the cost of preferred stock. B. increase both the cost of preferred stock and debt. C. decrease the firm's cost of capital. D. decrease the cost of equity capital. E. increase the firm's WACC.

C. decrease the firm's cost of capital.

5. Unsystematic risk can be defined by all of the following except: A. unrewarded risk. B. diversifiable risk. C. market risk. D. unique risk. E. asset-specific risk.

C. market risk

5. Kate is the CFO of a major firm and has the job of assigning discount rates to each project under consideration. Kate's method of doing this is to assign an incrementally higher rate as the risk level of the project increases and a lower rate as the risk level declines. Kate is applying the ___ approach. A. pure play B. divisional rating C. subjective D. straight WACC E. equity rating

C. subjective

13. A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock? A. An increase in the rate of return in a recessionary economy B. An increase in the probability of an economic boom C. A decrease in the probability of a recession occurring D. A decrease in the probability of an economic boom E. An increase in the rate of return for a normal economy

D. A decrease in the probability of an economic boom

22. Which one of these is the best example of systematic risk? A. Discovery of a major gas field B. Decrease in textile imports C. Increase in agricultural exports D. Decrease in gross domestic product E. Decrease in management bonuses for banking executives

D. Decrease in gross domestic product

16. Which one of the following statements is correct? A. The risk premium on a risk-free security is generally considered to be one percent. B. The expected rate of return on any security, given multiple states of the economy, must be positive. C. There is an inverse relationship between the level of risk and the risk premium given a risky security. D. If a risky security is correctly priced, its expected risk premium will be positive. E. If a risky security is priced correctly, it will have an expected return equal to the risk-free rate.

D. If a risky security is correctly priced, its expected risk premium will be positive.

6. Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? A. Amount of debt used to finance the project B. Use, or lack, of preferred stock as a financing option C. Mix of funds used to finance the project D. Risk level of the project E. Length of the project's life

D. Risk level of the project

7. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is primarily dependent on which one of the following? A. The firm's overall source of funds B. Source of the funds used to build the facility C. Current tax rate D. The nature of the investment E. Firm's historical average rate of return

D. The nature of the investment

15. The expected rate of return on Delaware Shores stock is based on three possible states of the economy. These states are boom, normal, and recession which have probabilities of occurrence of 20 percent, 75 percent, and 5 percent, respectively. Which one of the following statements is correct concerning the variance of the returns on this stock? A. The variance must decrease if the probability of occurrence for a boom increases. B. The variance will remain constant as long as the sum of the economic probabilities is 100 percent. C. The variance can be positive, zero, or negative, depending on the expected rate of return assigned to each economic state. D. The variance must be positive provided that each state of the economy produces a different expected rate of return. E. The variance is independent of the economic probabilities of occurrence.

D. The variance must be positive provided that each state of the economy produces a different expected rate of return.

11. The results of the dividend growth model: A. vary directly with the market rate of return. B. can only be applied to projects that have a growth rate equal to that of the current firm. C. are highly dependent upon the beta used in the model. D. are sensitive to the rate of dividend growth. E. are most reliable when the growth rate exceeds 10 percent.

D. are sensitive to the rate of dividend growth.

11. The security market line is defined as a positively sloped straight line that displays the relationship between the: A. beta and standard deviation of a portfolio. B. systematic and unsystematic risks of a security. C. nominal and real rates of return. D. expected return and beta of either a security or a portfolio. E. risk premium and beta of a portfolio.

D. expected return and beta of either a security or a portfolio.

10. When evaluating a project, the dividend growth model: A. can only be used by firms that pay increasing dividends. B. must be used by all dividend-paying firms. C. is only applicable when the growth rate of the project exceeds the dividend growth rate. D. is relatively simple to use. E. must use the growth rate of the project as the rate of growth in the formula.

D. is relatively simple to use.

7. The systematic risk principle states that the expected return on a risky asset depends only on the asset's ___ risk. A. unique B. diversifiable C. asset-specific D. market E. unsystematic

D. market

12. Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive? A. Risk-free rate B. Market risk premium C. Expected return minus the risk-free rate D. Market rate of return E. Cost of capital

E. Cost of capital

13. Assume a firm has a beta of 1.2. All else held constant, the cost of equity for this firm will increase if the: A. market risk premium decreases. B. risk-free rate decreases. C. market rate of return decreases. D. beta decreases. E. either the risk-free rate or the market rate of return decreases.

E. either the risk-free rate or the market rate of return decreases.

9. The security market line is a linear function that is graphed by plotting data points based on the relationship between the: A. risk-free rate and beta. B. market rate of return and beta. C. market rate of return and the risk-free rate. D. risk-free rate and the market rate of return. E. expected return and beta.

E. expected return and beta

12. In an efficient market, the cost of equity for a highly risky firm: A. will be less than the market rate but higher than the risk-free rate. B. must equal the market rate of return. C. changes by 1 percent for every 1 percent change in the risk-free rate. D. decreases as the beta of the firm's stock increases. E. increases in direct relation to the stock's systematic risk.

E. increases in direct relation to the stock's systematic risk.

11. Movements in individual stock prices tend to be a. positively correlated b. positively correlated with inflation c. negatively correlated d. positively correlated with changes in interest rates

a. positively correlated

5. An investment's internal rate of return equates a. dividend payments and capital gains b. cash outflows and subsequent cash inflows c. initial cash outflow and the sale price d. dividend payments and the investment's cost

b. cash outflows and subsequent cash inflows

8. Historical studies of rates of return on large stocks suggest a. the average return is about 6.4 percent annually b. over a period of years, the rate is approximately 10 percent c. equity investors rarely sustain losses d. dividends account for over half the return

b. over a period of years, the rate is approximately

9. Dollar cost averaging is a. periodically buying a round lot of stock b. periodically investing a specified dollar amount in a stock c. a means to increase the average cost basis d. a means to insure a positive return

b. periodically investing a specified dollar amount

6. The S&P 500 uses a. a simple average b. a compound average c. a geometric average d. a value-weighted average

d. a value-weighted average

4. To determine the realized return on an investment, the investor needs to know 1. income received 2. the cost of an investment 3. the sale price of the investment a. 1 and 2 b. 1 and 3 c. 2 and 3 d. all of the above

d. all of the above

10. A strategy of averaging down will be profitable if a. the price of the stock continues to fall b. the firm pays more dividends c. the firm retains earnings d. the price of the stock subsequently rises

d. the price of the stock subsequently rises