finance 300 final

You have $21,600 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14.3 percent and Stock Y with an expected return of 8.1 percent. Your goal is to create a portfolio with an expected return of 12.5 percent. All money must be invested. How much will you invest in Stock X?

$15,329

Assume an investment has cash flows of −$39,700, $21,750, $18,500, and $12,500 for Years 0 to 3, respectively. What is the NPV if the required return is 12.9 percent? Should the project be accepted or rejected?

$2,764.89; accept

A project will produce cash inflows of $5,400 a year for 3 years with a final cash inflow of $2,400 in Year 4. The project's initial cost is $13,400. What is the net present value if the required rate of return is 14.2 percent?

$505.92

If the economy is normal, Charleston Freight stock is expected to return 14.3 percent. If the economy falls into a recession, the stock's return is projected at a negative 8.7 percent. The probability of a normal economy is 80 percent. What is the variance of the returns on this stock?

. 008464

The rate of return on the common stock of Lancaster Woolens is expected to be 18 percent in a boom economy, 8 percent in a normal economy, and only 2 percent in a recessionary economy. The probabilities of these economic states are 12 percent for a boom and 10 percent for a recession. What is the variance of the returns on this common stock?

.001524

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

.71 WACC = .1173 = (E/V)(.158) + (D/V)(.076)(1 − .21) .1173(V/E) = .158 + .06004(D/E) .1173(1 + D/E) = .158 + .06004 (D/E) D/E = .71

Assume a project has cash flows of −$54,300, $18,200, $37,300, and $14,300 for Years 0 to 3, respectively. What is the profitability index given a required return of 12.6 percent?

1.02

A project has cash flows of −$152,000, $60,800, $62,300 and $75,000 for Years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value?

1.02; accept

Christina purchased 500 shares of stock at a price of $62.30 a share and sold the shares for $64.25 each. She also received $738 in dividends. If the inflation rate was 3.9 percent, what was her exact real rate of return on this investment?

1.54 percent

The common stock of Jensen Shipping has an expected return of 15.4 percent. The return on the market is 11.2 percent, the inflation rate is 3.1 percent, and the risk-free rate of return is 3.6 percent. What is the beta of this stock?

1.55

You are comparing Stock A to Stock B. Given the following information, what is the difference in the expected returns of these two securities? State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Normal .75 .13 .16 Recession .25 − .05 − .21

1.75 percent

Southern Bakeries just paid its annual dividend of $.48 a share. The stock has a market price of $17.23 and a beta of .93. The return on the U.S. Treasury bill is 3.1 percent and the market risk premium is 7.6 percent. What is the cost of equity?

10.17 percent RE = .031 + .93(.076) RE = .1017, or 10.17%

Suppose you observe the following situation: Security Beta Expected Return A 1.16 .1137 B .92 .0984 Assume these securities are correctly priced. Based on the CAPM, what is the return on the market?

10.35 percent

Dee's Fashions has a growth rate of 3.2 percent and is equally as risky as the market while its stock is currently selling for $32 a share. The overall stock market has a return of 10.9 percent and a risk premium of 6.8 percent. What is the expected rate of return on this stock?

10.9 percent RE = (.109 − .068) + 1(.068) RE = .109, or 10.9%

What is the expected return of an equally weighted portfolio comprised of the following three stocks? State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom .25 .19 .13 .07 Normal .72 .15 .05 .13 Bust .03 − .29 − .14 .22

10.96 percent

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

12.06 percent WACC = (1/1.62)(.163) + (.62/1.62)(.0521) WACC = .1206, or 12.06%

Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share?

12.24 percent RP = .06($100)/$49 RP = .1224, or 12.24%

Suppose you bought a $1,000 face value bond with a coupon rate of 5.6 percent one year ago. The purchase price was $987.50. You sold the bond today for $994.20. If the inflation rate last year was 2.6 percent, what was your exact real rate of return on this investment?

3.65 percent

Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the aftertax cost of debt if the company's combined tax rate is 23 percent?

4.78 percent 1.08($1,000) = [.07($1,000)/2][(1 − {1/[1 + (r/2)]16(2)})/(r/2)] + $1,000/[1 + (r/2)]16(2) Using trial-and-error, a financial calculator, or a computer: r = 6.204 percent RD Aftertax = 6.204%(1 − .23) RD Aftertax = 4.78%

A stock had returns of 13 percent, 11 percent, 8 percent, 14 percent, −9 percent, and −5 percent over the past six years. What is the geometric average return for this time period?

4.93 percent

Fashion Wear has bonds outstanding that mature in 11 years, pay interest annually, and have a coupon rate of 6.45 percent. These bonds have a face value of $1,000 and a current market price of $994. What is the company's aftertax cost of debt if its tax rate is 21 percent?

5.16 percent $994 = (.0645)($1,000)({1 − [1/(1 + r)11]}/r) + $1,000/(1 + r)11 Using trial-and-error, a financial calculator, or a computer: r = 6.528 percent Aftertax cost of debt = 6.528%(1 − .21) Aftertax cost of debt = 5.16%

The Downtowner has 168,000 shares of common stock outstanding valued at $53 a share along with 13,000 bonds selling for $1,008 each. What weight should be given to the debt when the company computes its weighted average cost of capital?

59.54 percent D = 13,000($1,008) = $ 13,104,000 E = 168,000($53) = $ 8,904,000 V = $13,104,000 + 8,904,000 V = $22,008,000 WD = $13,104,000/$22,008,000 WD = .5954, or 59.54%

You bought one of Shark Repellant's 6 percent coupon bonds one year ago for $867. These bonds pay annual payments, have a face value of $1,000, and mature 12 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 7.4 percent. The inflation rate over the past year was 2.9 percent. What was your total real return on this investment?

6.61 percent

What is the expected return on a portfolio that is invested 22 percent in Stock A, 36 percent in Stock B, and the remainder in Stock C? State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom .05 .18 .11 .13 Normal .92 .09 .08 .06 Bust .03 − .07 .05 − .14

7.29 percent

Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity?

7.83 percent RE = ($1.26/$24.09) + .026 RE = .0783, or 7.83%

A project has cash flows of -$148,400, $42,500, $87,300, and $43,200 for Years 0 to 3, respectively. The required rate of return is 11 percent. Based on the internal rate of return of _____ percent for this project, you should _____ the project.

8.03; reject

Holdup Bank has an issue of preferred stock with a stated dividend of $7 that just sold for $87 per share. What is the bank's cost of preferred?

8.05 percent RP = $7/$87 RP = .0805, or 8.05%

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 a share. The common stock has a beta of 1.32 and sells for $41 a 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?

8.09 percent 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%

A stock had returns of 5 percent, 14 percent, 11 percent, −8 percent, and 6 percent over the past five years. What is the standard deviation of these returns?

8.44 percent

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 3.18 percent and the market rate of return is 11.27 percent. What is the risk premium on this stock?

8.82 percent

The market has an expected rate of return of 12.6 percent. The long-term government bond is expected to yield 4.8 percent and the U.S. Treasury bill is expected to yield 2.7 percent. The inflation rate is 3.2 percent. What is the market risk premium?

9.9 percent

Which one of the following statements is correct concerning market efficiency?

A firm will generally receive a fair price when it issues new shares of stock if the market is efficient.

Which one of the following is the best example of a diversifiable risk?

A firm's sales decrease

Precision Dyes is analyzing two machines to determine which one it should purchase. The company requires a rate of return of 15 percent and uses straight-line depreciation to a zero book value over the life of its equipment. Ignore bonus depreciation. Machine A has a cost of $462,000, annual aftertax cash outflows of $46,200, and a four-year life. Machine B costs $898,000, has annual aftertax cash outflows of $16,500, and has a seven-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should the company purchase and how much less is that machine's EAC as compared to the other machine's?

A; $24,321.02

You are considering two mutually exclusive projects. Project A has cash flows of −$72,000, $21,400, $22,900, and $56,300 for Years 0 to 3, respectively. Project B has cash flows of −$81,000, $20,100, $22,200, and $74,800 for Years 0 to 3, respectively. Both projects have a required 2.5-year payback period. Should you accept or reject these projects based on payback analysis?

Accept Project A and reject Project B

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be?

Accept Project B and reject Project A based on the NPVs

Which one of the following stocks is correctly priced if the risk-free rate of return is 2.84 percent and the market rate of return is 10.63 percent? Stock Beta Expected Return A .93 .0892 B 1.18 .1203 C 1.47 .1540 D 1.02 .1006 E 1.26 .1187

B

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

Generally speaking, which of the following best correspond to a wide frequency distribution?

High standard deviation, large risk premium

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 will decrease the net present value of a project?

Increasing the project's initial cost at time zero

In actual practice, managers most frequently use which two types of investment criteria?

Internal rate of return and net present value

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

Investors panic causing security prices around the globe to fall precipitously

A stock had annual returns of 5.3 percent, −2.7 percent, 16.2 percent, and 13.6 percent over the past four years. Which one of the following best describes the probability that this stock will produce a return of 20 percent or more in a single year?

Less than 16 percent but more than 2.5 percent

Which of the following are advantages of the payback method of project analysis?

Liquidity bias, ease of use

Which one of the following is a project acceptance indicator given an independent project with investing type cash flows?

Modified internal rate of return that exceeds the required return

You are viewing a graph that plots the NPVs of a project to various discount rates that could be applied to the project's cash flows. What is the name given to this graph?

NPV profile

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

National decrease in consumer spending on entertainment

The profitability index is most closely related to which one of the following?

Net present value

Scott is considering a project that will produce cash inflows of $2,900 a year for 3 years. The required rate of return is 15.4 percent and the initial cost is $6,800. What is the discounted payback period?

Never

You estimate that a project will cost $33,700 and will provide cash inflows of $14,800 in Year 1 and $24,600 in Year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14.2 percent? Why or why not?

No; The PI is .87.

Which two methods of project analysis are the most biased towards short-term projects?

Payback and discounted payback

Which one of the following characteristics is most associated with financing type projects?

Prepaid services

JJ's is reviewing a project with a required discount rate of 15.2 percent and an initial cost of $309,000. The cash inflows are $47,000, $198,000, and $226,000 for Years 2 to 4, respectively. Should the project be accepted based on discounted payback if the required payback period is 2.5 years?

Reject; The project never pays back on a discounted basis.

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

Reward-to-risk ratio

Assume that last year T-bills returned 2.8 percent while your investment in large-company stocks earned an average of 7.6 percent. Which one of the following terms refers to the difference between these two rates of return?

Risk premium

Which one of the following categories of securities had the most volatile annual returns over the period 1926-2016?

Small-company stocks

Which one of the following is a risk that applies to most securities?

Systematic

The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information?

The actual expected stock return indicates the stock is currently overpriced

You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 1.04, an NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information?

The discount rate used in computing the net present value was less than 11.63 percent.

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient.

The information was expected.

A project has a net present value of zero. Which one of the following best describes this project?

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

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.

Standard deviation is a measure of which one of the following?

Volatility

A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for Years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not?

Yes; The IRR exceeds the required return.

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.

You are considering two independent projects. Project A has an initial cost of $125,000 and cash inflows of $46,000, $79,000, and $51,000 for Years 1 to 3, respectively. Project B costs $135,000 with expected cash inflows for Years 1 to 3 of $50,000, $30,000, and $100,000, respectively. The required return for both projects is 16 percent. Based on IRR, you should:

accept Project A and reject Project B.

The return earned in an average year over a multiyear period is called the _____ average return.

arithmetic

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

The standard deviation of a portfolio:

can be less than the standard deviation of the least risky security in the portfolio.

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 IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:

crossover rate

The internal rate of return is defined as the:

discount rate which causes the net present value of a project to equal zero.

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 .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 average compound return earned per year over a multiyear period is called the _____ average return.

geometric

There are two distinct discount rates at which a particular project will have a zero net present value. In this situation, the project is said to:

have multiple rates of return.

Graphing the crossover point helps explain:

how decisions concerning mutually exclusive projects are derived.

To convince investors to accept greater volatility, you must:

increase the risk premium.

The dividend growth model:

is only as reliable as the estimated rate of growth

Net present value:

is the best method of analyzing mutually exclusive projects.

Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock:

is underpriced.

You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines that have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine that has the:

lowest equivalent annual cost.

Estimates of the rate of return on a security based on the historical arithmetic average will probably tend to _____ the expected return for the long-term and estimates using the historical geometric average will probably tend to _____ the expected return for the short-term.

overestimate; underestimate

The weighted average cost of capital for a firm with debt is the:

rate of return a company must earn on its existing assets to maintain the current value of its stock.

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

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

risk premium

Small-company stocks, as the term is used in the textbook, are best defined as the:

smallest 20 percent of the companies listed on the NYSE.

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient

strong

Inside information has the least value when financial markets are:

strong form efficient.

Efficient financial markets fluctuate continuously because:

the markets are continually reacting to new information.

If a project has a net present value equal to zero, then:

the project earns a return exactly equal to the discount rate.

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

the risk-free rate.

The equivalent annual cost method is useful in determining:

which one of two machines should be purchased when the machines are mutually exclusive, have differing lives, and will be replaced at the end of their lives.

ALUM Inc. uses high-tech equipment to produce specialized products. Each one of its machines costs $1,243,000 to purchase plus an additional $78,000 a year to operate. The machines have a five-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16.5 percent?

−$462,061.04