fin e2-2
A statistical measure of the degree to which securities' returns move together is called
Correlation coefficient
54. Opportunity costs should not be included in project analysis, as they are missed opportunities.
FALSE
54. The distribution of annual returns over long periods for stocks is more closely related to the normal distribution than the lognormal distribution.
FALSE
54. Treasury bills typically provide higher average returns, both in nominal terms and in real terms, than long-term government bonds.
FALSE
56. For log normally distributed returns, the annual geometric average return is greater than the arithmetic average return.
FALSE
56. If two investments offer the same expected return, then most investors would prefer the one with higher variance.
FALSE
57. By undertaking an analysis in real terms, the financial manager avoids having to forecast inflation.
FALSE
58. A financial analyst should include interest and dividend payments when calculating a project's cash flows.
FALSE
58. Investors mainly worry about those risks that can be eliminated through diversification.
FALSE
58. The standard statistical measures of the variability of stock returns are beta and covariance
FALSE
60. The portfolio risk that cannot be eliminated by diversification is called unique risk.
FALSE
61. In theory, the CAPM requires that the market portfolio consist of only common stocks.
FALSE
61. Within the MACRS system of depreciation, most industrial equipment falls into the 10-15 year classes.
FALSE
63. Almost all tests of the CAPM have confirmed that it explains stock returns, especially for high-beta stocks.
FALSE
63. The average beta of all stocks in the market is zero.
FALSE
64. A portfolio with a beta of one offers an expected return equal to the market risk premium.
FALSE
64. The arbitrage pricing theory (APT) implies that the market portfolio is efficient.
FALSE
64. The rule for comparing machines with different lives is to select the machine with the greatest equivalent annual cost (EAC).
FALSE
65. Stocks with high standard deviations will necessarily also have high betas.
FALSE
66. Low standard deviation stocks always have low betas.
FALSE
67. The equivalent annual cash-flow technique is primarily used whenever the lives of two different projects are the same.
FALSE
68. By purchasing U.S. government bonds, an investor can achieve both a risk-free nominal rate of return and a risk-free real rate of return.
FALSE
70. One can easily calculate the estimated risk premium on stocks via the statistical analysis of historical stock returns.
FALSE
71. The standard deviation of a two-stock portfolio generally equals the value-weighted average of the standard deviations of the two stocks.
FALSE
73. Risk-free U.S. Treasury bills have a beta greater than zero.
FALSE
74. Underpriced stocks will plot below the security market line.
FALSE
76. The variability of a well-diversified portfolio mostly reflects the contributions to risk from the standard deviations of the stocks within that portfolio.
FALSE
77. Overpriced stocks will plot above the security market line.
FALSE
If a firm permanently borrows $50 million at an interest rate of 10 percent, what is the present value of the interest tax shield? Assume a 30 percent marginal corporate tax rate.
$15 million
If a firm permanently borrows $100 million at an interest rate of 8 percent, what is the present value of the interest tax shield? (Assume that the marginal corporate tax rate is 30 percent.)
$30 million
What range of values can correlation coefficients take?
-1 to +1
For a two-stock portfolio, the maximum reduction in risk occurs when the correlation coefficient between the two stocks equals:
-1.0
The correlation coefficient between a stock and the market portfolio is +0.6. The standard deviation of return of the stock is 30 percent and that of the market portfolio is 20 percent. Calculate the beta of the stock.
.9
If a firm borrows $50 million for one year at an interest rate of 9 percent, what is the present value of the interest tax shield? Assume a 30 percent marginal corporate tax rate.
1.24 million
The covariance between YOHO stock and the S&P 500 is 0.05. The standard deviation of the stock market is 20 percent. What is the beta of YOHO?
1.25
What is the relative tax advantage of debt? Assume that personal and corporate taxes are given by TC = (corporate tax rate) = 35 percent; TpE = personal tax rate on equity income = 30 percent; and Tp = personal tax rate on interest income = 20 percent.
1.76
Assume the following data for U&P Company: Debt (D) = $100 million; Equity (E) = $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC):
10.05%
Suppose the beta of Exxon-Mobil is 0.65, the risk-free rate is 4 percent, and the expected market rate of return is 14 percent. Calculate the expected rate of return on Exxon-Mobil.
10.5%
A firm has a total market value of $10 million while its debt has a market value of $4 million. What is the after-tax weighted average cost of capital if the before-tax cost of debt is 10 percent, the cost of equity is 15 percent, and the tax rate is 35 percent?
11.6%
Assume the following data: Risk-free rate = 4.0 percent; average risk premium = 7.7 percent. Calculate the required rate of return for the risky asset.
11.7%
Suppose the beta of Microsoft is 1.13, the risk-free rate is 3 percent, and the market risk premium is 8 percent. Calculate the expected return for Microsoft.
12.04%
A firm has zero debt in its capital structure. Its overall cost of capital is 10 percent. The firm is considering a new capital structure with 60 percent debt. The interest rate on the debt would be 8 percent. Assuming there are no taxes, its cost of equity capital with the new capital structure would be
13%
A firm's return on assets is 12 percent and the cost of the firm's debt is 7 percent. Given a 0.7 debt-equity-ratio, what is the levered cost of equity? Assume that there are no taxes.
15.5%
Stock A has an expected return of 10 percent per year and stock B has an expected return of 20 percent. If 40 percent of a portfolio's funds are invested in stock A and the rest in stock B, what is the expected return on the portfolio of stock A and stock B?
16%
The M&M Company is financed by $10 million in debt (market value) and $40 million in equity (market value). The cost of debt is 10 percent and the cost of equity is 20 percent. Calculate the weighted average cost of capital, assuming no taxes.
18%
Suppose the beta of Amazon is 2.2, the risk-free rate is 5.5 percent, and the market risk premium is 8 percent. Calculate the expected rate of return for Amazon.
23.1%
If the average annual rate of return for common stocks is 11.7 percent, and 4.0 percent for U.S. Treasury bills, what is the average market risk premium?
7.7%
Given are the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%; Marginal tax rate = 35%; and the firm has 50 percent debt and 50 percent equity. Calculate the after-tax weighted average cost of capital (WACC).
8%
The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5 percent and the cost of equity is 10 percent. Calculate the weighted average cost of capital. (Assume no taxes.)
8%
Suppose you invest equal amounts in a portfolio with an expected return of 16 percent and a standard deviation of returns of 18 percent and a risk-free asset with an interest rate of 4 percent. Calculate the expected return on the resulting portfolio.
9%
For long-term U.S. government bonds, which risk concerns investors the most?
Interest rate risk
For a portfolio of N-stocks, the formula for portfolio variance contains
N(N-1)/2 different covariance terms
What is an estimate of standard error?
The standard deviation of returns divided by the square root of the number of observations.
Assume the following data for a stock: Beta = 0.9; risk-free rate = 4 percent; market rate of return = 14 percent; and expected rate of return on the stock = 13 percent. Then the stock is
correctly priced
Unique risk is also called
firm-specific risk
Assume the following data for a stock: Beta = 1.5; risk-free rate = 4 percent; market rate of return = 12 percent; and expected rate of return on the stock = 15 percent. Then the stock is
overpriced
Assume the following data for a stock: Beta = 0.5; risk-free rate = 4 percent; market rate of return = 12 percent; and expected rate of return on the stock = 10 percent. Then the stock is
underpriced
62. According to the CAPM, the market portfolio is a tangency portfolio.
TRUE
62. Most large U.S. corporations keep two separate sets of books, one for stockholders and one for the Internal Revenue Service.
TRUE
62. The beta of a well-diversified portfolio is equal to the value weighted average beta of the securities included in the portfolio.
TRUE
63. A financial analyst can use the equivalent annual cash-flow approach to determine the year in which an existing machine can be profitably replaced with a new machine.
TRUE
65. Both the CAPM and the APT stress that unique risk does not affect expected return.
TRUE
65. You should replace a machine when the EAC of continuing to operate it exceeds the EAC of the new machine.
TRUE
66. It is not possible to earn a return that is above the efficient frontier of common stocks without the existence of a risk-free asset or some other asset that is uncorrelated with your portfolio assets.
TRUE
66. When evaluating mutually exclusive projects with positive NPV but different life spans, the proper technique to employ is the equivalent annual cash-flow approach.
TRUE
67. A stock having a covariance with the market that is higher than the variance of the market will always have a beta above 1.0.
TRUE
67. In addition to common stocks, the addition of real estate (as an investment alternative) will likely expand the efficient frontier to a better risk-return trade-off.
TRUE
68. Most investors dislike uncertainty.
TRUE
69. A risk premium generated by comparing stocks to 10-year U.S. Treasury bonds will be smaller than a risk premium generated by comparing stocks to U.S. Treasury bills.
TRUE
69. On an expected return versus standard deviation diagram (with expected return on the vertical axis), most investors prefer portfolios that appear more towards the top and the left.
TRUE
70.The correlation between the return on a risk-free asset and the return on any common stock will equal zero.
TRUE
71. All else equal, investors prefer to choose from portfolios having higher Sharpe ratios.
TRUE
72. Risk-free U.S. Treasury bills have a beta of zero.
TRUE
72. The covariance between the returns on two stocks equals the correlation coefficient multiplied by the standard deviations of the two stocks.
TRUE
73. For the most part, stock returns tend to move together. Thus, pairs of stocks tend to have both positive covariances and correlations.
TRUE
74. If returns on two stocks tended to move in opposite directions, then the covariances and correlations on the two stocks would be negative.
TRUE
75. Diversification can reduce portfolio risk even in the case when correlations across stock returns equal zero.
TRUE
75. Underpriced stocks will plot above the security market line
TRUE
76. Overpriced stocks will plot below the security market line.
TRUE
77. The risk of a well-diversified portfolio depends on the market risk of the securities included in the portfolio.
TRUE
If a firm borrows $50 million for one year at an interest rate of 10 percent, what is the present value of the interest tax shield? Assume a 30 percent marginal corporate tax rate.
$1.36 million
Assume the marginal corporate tax rate is 30 percent. The firm has no debt in its capital structure. It is valued at $100 million. What would be the value of the firm if it issued $50 million in perpetual debt and repurchased the same amount of equity?
$115 million
What is the correct measure of the opportunity cost of capital regardless of the timing of cash flows?
Arithmetic Average
53. The distribution of daily returns over short periods for stocks is more closely related to the normal distribution than the lognormal distribution.
TRUE
53. When calculating cash flows, one should consider all incidental effects.
TRUE
55. A risk premium is the difference between a security's return and the Treasury bill return.
TRUE
55. If the expected return of stock A is 12 percent and that of stock B is 14 percent, and both have the same variance, then nondiversified investors would prefer stock B to stock A.
TRUE
55. Working capital is needed for additional investment within a project and should be included within cash-flow estimates.
TRUE
56. Sunk costs are bygones (i.e., they are unaffected by the decision to accept or reject a project). They should therefore be ignored.
TRUE
57. According to the authors, a reasonable range for the risk premium in the United States is 5 percent to 8 percent.
TRUE
57. Portfolios that offer the highest expected return for a given variance (or standard deviation) are known as efficient portfolios.
TRUE
59. Beta measures the marginal contribution of a stock to the risk of a well-diversified portfolio.
TRUE
59. Depreciation expense acts as a tax shield in reducing taxes.
TRUE
59. Diversification reduces the risk of a portfolio because the prices of different securities do not move exactly together.
TRUE
60. According to the CAPM, all investments plot along the security market line.
TRUE
60. Working capital is one of the most common sources of mistakes in estimating project cash flows.
TRUE
61. The portfolio risk that cannot be eliminated by diversification is called market risk.
TRUE