FIN300 Exam 3 Ch.13 & 14

You have $10,000 to invest in a stock portfolio. Your choices are stock X with an expected return of 13 percent and stock Y with an expected return of 8 percent. Your goal is to create a portfolio with an expected return of 12.4 percent. All money must be invested. How much will you invest in stock X?

$8,800

The rate of return on the common stock of Lancaster Woolens is expected to be 21 percent in a boom economy, 11 percent in a normal economy, and only 3 percent in a recessionary economy. The probabilities of these economic states are 10 percent for a boom, 70 percent for a normal economy, and 20 percent for a recession. What is the variance of the returns on this common stock?

0.002244

If the economy is normal, Charleston Freight stock is expected to return 16.5 percent. If the economy falls into a recession, the stock's return is projected at a negative 11.6 percent. The probability of a normal economy is 80 percent while the probability of a recession is 20 percent. What is the variance of the returns on this stock?

0.012634

You own a stock portfolio invested 35 percent in Stock Q, 20 percent in Stock R, 15 percent in Stock S, and 30 percent in Stock T. The betas for these four stocks are 1.24, 0.71, 0.89, and 0.73, respectively. What is the portfolio beta?

0.93

Southern Home Cooking just paid its annual dividend of $.75 a share. The stock has a market price of $16.80 and a beta of 1.14. The return on the U.S. Treasury bill is 2.7 percent and the market risk premium is 7.1 percent. What is the cost of equity?

10.79 percent

Dee's Fashions has a growth rate of 5.2 percent and is equally as risky as the market while its stock is currently selling for $28 a share. The overall stock market has a return of 12.6 percent and a risk premium of 8.7 percent. What is the expected rate of return on this stock?

12.6 percent

Filer Manufacturing has 7 million shares of common stock outstanding. The current share price is $86, and the book value per share is $5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70 million, has a 9 percent coupon, and sells for 96 percent of par. The second issue has a face value of $45 million, has a 10 percent coupon, and sells for 104 percent of par. The first issue matures in 24 years, the second in 6 years. The most recent dividend was $5.8 and the dividend growth rate is 7 percent. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 34 percent.

12.93%

You own a portfolio that has $2,450 invested in Stock A and $3,950 invested in Stock B. If the expected returns on these stocks are 8 percent and 18 percent, respectively, what is the expected return on the portfolio?

14.17%

Sixx AM Manufacturing has a target debt—equity ratio of 0.52. Its cost of equity is 18 percent, and its cost of debt is 11 percent. If the tax rate is 34 percent, what is the company's WACC?

14.33%

Assume these securities are correctly priced. Based on the CAPM, what is the return on the market?

14.67 percent

What is the expected return of an equally weighted portfolio comprised of the following three stocks?

18.60 percent

A stock has an expected return of 16 percent, its beta is 0.8, and the risk-free rate is 5.6 percent. What must the expected return on the market be?

18.60%

You are comparing Stock A to Stock B. Given the following information, what is the difference in the expected returns of these two securities?

2.70 percent

Stock Y has a beta of 1.4 and an expected return of 15.2 percent. Stock Z has a beta of .7 and an expected return of 9.1 percent. What would the risk-free rate have to be for the two stocks to be correctly priced?

3.00

Fashion Wear has bonds outstanding that mature in 12 years, pay interest annually, and have a coupon rate of 7.5 percent. These bonds have a face value of $1,000 and a current market price of $1,060. What is the company's aftertax cost of debt if its tax rate is 35 percent?

4.39 percent

Jiminy's Cricket Farm issued a 30-year, 8 percent, semiannual bond six years ago. The bond currently sells for 114 percent of its face value. What is the aftertax cost of debt if the company's tax rate is 31 percent?

4.70 percent

What is the expected return on a portfolio that is invested 25 percent in stock A, 55 percent in stock B, and the remainder in stock C?

5.93 percent

The Downtowner has 950,000 shares of common stock outstanding valued at $38 a share along with 40,000 bonds selling for $1,020 each. What weight should be given to the debt when the firm computes its weighted average cost of capital?

53.06 percent

The market has an expected rate of return of 11.2 percent. The long-term government bond is expected to yield 5.8 percent and the U.S. Treasury bill is expected to yield 3.9 percent. The inflation rate is 3.6 percent. What is the market risk premium?

7.3 percent

The Pet Market has $1,000 face value bonds outstanding with 18 years to maturity, a coupon rate of 9 percent, annual interest payments, and a current price of $835. What is the aftertax cost of debt if the tax rate is 34 percent?

7.37 percent

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75 percent and the market rate of return is 9.80 percent. What is the risk premium on this stock?

7.68 percent

Chelsea Fashions is expected to pay an annual dividend of $1.10 a share next year. The market price of the stock is $21.80 and the growth rate is 4.5 percent. What is the firm's cost of equity?

9.55percent

Phillips Equipment has 75,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5 percent. The company also has 750,000 shares of 6 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.21 and sells for $44 a share. The U.S. Treasury bill is yielding 2.3 percent and the return on the market is 11.2 percent. The corporate tax rate is 34 percent. What is the firm's weighted average cost of capital?

9.69percent

Holdup Bank has an issue of preferred stock with a $9 stated dividend that just sold for $91 per share. What is the bank's cost of preferred stock?

9.89%

A stock with an actual return that lies above the security market line has:

A higher return than expected for the level of risk assumed.

Unsystematic risk:

Can be effectively eliminated by portfolio diversification.

The standard deviation of a portfolio:

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

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

Capital asset pricing model

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the:

Cost of capital.

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:

Either stock A is overpriced or stock B is underpriced or both.

The dividend growth model cannot be used to compute the cost of equity for a firm that:

Has a retention ratio of 100 percent.

Which of the following statements concerning risk are correct? I. Non diversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for non diversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only.

Which one of the following is an example of systematic risk?

Investors panic causing security prices around the globe to fall precipitously.

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

Is underpriced.

Which one of the following is represented by the slope of the security market line?

Market risk premium

The cost of preferred stock is computed the same as the:

Rate of return on a perpetuity.

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

Risk premium

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

Security market line

The weighted average cost of capital for a firm can depend on all of the following except the:

Standard deviation of the firm's common stock.

The intercept point of the security market line is the rate of return which corresponds to:

The risk-free rate.

Which one of the following statements related to unexpected returns is correct?

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