finance chapter 11,12,13---wrong dont look at

Macro events only are reflected in the performance of the market portfolio because:

the unique risks have been diversified away.

To calculate the present value of a business, the firm's free cash flows should be discounted at the firm's:

weighted-average cost of capital.

Suppose an analyst estimates that free cash flow will be $2.43 million in year 5. What is the present value of this free cash flow if the company cost of capital is 12%, the WACC is 10%, and the equity cost of capital is 15%?

$1,508,839 PV = $2.43m/1.105 = $1,508,839

How much cash flow before tax and interest is necessary to support a project that requires $4 million annually for equity investors and $2 million annually in interest payments if the firm's tax rate is 35%?

$8.15 million Working up from the bottom cash flow before tax $8.15mil interest 2.00mil ----------- pretax cash flow 6.15 mil tax 2.15 mil ------------------- after tax cash flow 4.0mill

What is the beta of a 3-stock portfolio including 25% of stock A with a beta of 0.90, 40% of stock B with a beta of 1.05, and 35% of stock C with a beta of 1.73?

1.25 βPortfolio = 0.25 × 0.9 + 0.4 × 1.05 + 0.35 × 1.73 = 1.25

If a security plots below the security market line, it is:

offering too little return to justify its risk.

The basic tenet of the CAPM is that a stock's expected risk premium should be:

proportionate to the stock's beta.

The yield-to-maturity of a firm's bond is 8.5%. The firm has a beta of 1.3 and a tax rate of 34%. The market risk premium is 8.4% and the risk-free rate is 3.8%. What is the firm's WACC if the firm has a capital structure that is 40% debt financed?

11.08% re = 3.8% + 1.3(8.4%) = 14.72% WACC = (1 - 0.40)(0.1472) + 0.40(.085)(1 - 0.34) = 0.1108, or 11.08%

What is the WACC for a firm with 40% debt, 20% preferred stock, and 40% equity if the respective costs for these components are 9.23% before tax, 12% after tax, and 18% before tax? The firm's tax rate is 35%.

12% WACC = [0.4 × (1 - 0.35 × 9.23%)] + (0.2 × 12%) + (0.4 × 18%) = 12.0%

A firm with a beta of 1.22 just paid its annual dividend of $5.64 a share. The dividends increase at a rate of 2% annually. The risk-free rate is 3.5%, the market rate of return is 12.4%, and the dividend discount rate is 11.6%. What is the best estimate of the firm's cost of equity if the firm's stock currently sells for $60 a share using an average of methods?

12.97% re = 0.035 + 1.22(0.124 - 0.035) = 0.14358, or 14.358% re = ($5.64 × 1.02)/$60 + 0.02 = 0.11588, or 11.588% Average = (14.358% + 11.588)/2 = 12.97%

According to CAPM estimates, what is the cost of equity for a firm with a beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?

19.5% Re = 6% + 1.5(15% - 6) = 19.5%

Company X has 2 million shares of common stock outstanding at a book value of $2 per share. The stock trades for $3 per share. It also has $2 million in face value of debt that trades at 90% of par. What is the weight of debt for WACC purposes?

23.08% Weight of debt = (0.90 × $2m)/[(2m × $3) + (0.90 × $2m)] = 0.2308, or 23.08%

What appears to be the targeted debt ratio of a firm that issues $15 million in bonds and $35 million in equity to finance its new capital projects?

30% Debt ratio = $15m/($15m + 35m) = 0.30, or 30%

chap 11: A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%. If the stock is perceived to be fairly priced today, what must be investors' expectation of the price of the stock at the end of the

52.625 From the CAPM, the appropriate discount rate is: r = rf + β(rm - rf) = 4% + (.75 × 7%) = 9.25% r = .0925 = Dividend + Capital gain = $2 + (P1 - $50) 2formula17.mml P1 = $52.625 Price $50

What proportion of a firm is equity financed if the WACC is 14%, the after-tax cost of debt is 7%, the tax rate is 35%, and the required return on equity is 18%?

63.64% 14% = (1 - x)(7%) + (x)18%; x = 63.64%

A firm has 12,500 shares of stock outstanding that sell for $42 each. The book value of equity is $400,000. The firm has also issued $250,000 face value of debt that is currently quoted at 101.2. What value should be used as the weight of equity when computing WACC?

67.48% We = (12,500 × $42)/[(12,500 × $42) + 1.012($250,000)] = 0.6748, or 67.48%

The weighted-average cost of capital for a firm with a 65/35 debt/equity split, 8% pre-tax cost of debt, 15% cost of equity, and a 35% tax rate would be:

8.63% WACC = [0.65 × .08 × (1 - 0.35)] + (0.35 × 0.15) = 0.0863, or 8.63%

What is the after-tax cost of preferred stock that sells for $10 per share and offers a $1.20 dividend when the tax rate is 35%?

Cost of preferred = $1.20/$10.00 = 0.12, or 12%

XYZ Company issues common stock at a price of $25 a share. The firm expects to pay a dividend of $2.20 a share next year. If the dividend is expected to grow at 2.5% annually, what is XYZ's cost of common equity?

re = $1.20/$25 + 0.025 = 0.113, or 11.3%

Stock A has a beta of .5, and investors expect it to return 5%. Stock B has a beta of 1.5, and investors expect it to return 13%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market. (Enter your answers as a whole percent.)

Market risk premium8 ± 1% Expected market rate of return 9 ± 1% Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. r = rf + β(rm − rf) Using the CAPM relationship, we can see that a change in beta will change the rate of return by the change in beta × market risk premium. So, solving for the market risk premium: MRP = (13% - 5%) / (1.5 - .5) = 8% Given the market risk premium, we can now solve for the risk-free rate using Stock A (It doesn't matter which stock you use.): .05 = rf + .5(.08) rf = .01, or 1% We know the beta of the market is 1,so the market rate of return is: Market return = 1% + 1(8%) = 9%

Stock A has a beta of .5, and investors expect it to return 5%. Stock B has a beta of 1.5, and investors expect it to return 13%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market. (Enter your answers as a whole percent.)

Market risk premium8 ± 1% Expected market rate of return 9 ± 1% Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. r = rf + β(rm − rf) Using the CAPM relationship, we can see that a change in beta will change the rate of return by the change in beta × market risk premium. So, solving for the market risk premium: MRP = (13% - 5%) / (1.5 - .5) = 8% Given the market risk premium, we can now solve for the risk-free rate using Stock A (It doesn't matter which stock you use.): .05 = rf + .5(.08) rf = .01, or 1% We know the beta of the market is 1,so the market rate of return is: Market return = 1% + 1(8%) = 9%

A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%. If the stock is perceived to be fairly priced today, what must be investors' expectation of the price of the stock at the end of the year? (Do not round intermediate calculations. Round your answer to 3 decimal places.)

Stock price $ 52.625 ± 1% Explanation: From the CAPM, the appropriate discount rate is: r = rf + β(rm - rf) = 4% + (.75 × 7%) = 9.25% r = .0925 = Dividend + Capital gain = $2 + (P1 - $50) 2formula17.mml P1 = $52.625 Price $50

Why is debt financing said to include a tax shield for the company?

Taxable income is reduced by the amount of the interest.

Which one of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%?

The S&P 500 would be expected to yield about 17.00%. E(R) = 7.5% + 1(9.5%) = 17%

What will be the effect of using the book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued?

The debt-to-value ratio will be understated.

Which one of the following statements best explains the fact that cyclical firms tend to have high betas?

Their earnings are not stable.

Olympic Sports has two issues of debt outstanding. One is a 8% coupon bond with a face value of $31 million, a maturity of 10 years, and a yield to maturity of 9%. The coupons are paid annually. The other bond issue has a maturity of 15 years, with coupons also paid annually, and a coupon rate of 9%. The face value of the issue is $36 million, and the issue sells for 93% of par value. The firm's tax rate is 35%. What is the before-tax cost of debt for Olympic? What is Olympic's after-tax cost of debt?

a 9.49% ± 1% b. 6.17% ± 1% a. First, compute the price of the 8% coupon bonds for each $1,000 of face value: PV = [(.08 × $1,000) × (1 / .09 - {1 / [.09(1 + .09)10]})] + $1,000 / (1 + .09)10 = $935.82 This means that each 8% coupon bond is selling for 93.582% of face value. Thus, the total market value of the issue is: Market value = .93582 × $31m = $29,010,526 The 9% coupon bonds are selling at 93% of face value, thus the market value of that issue is: Market value = .93 × $36m = $33,480,000 Total market value = $29,010,526 + 33,480,000 = $62,490,526 We also need to know the yield to maturity for the 9% bonds: PV = $930 = [(.09 × $1,000) × ((1 / r) - {1 / [r(1 + r)15]})] + $1,000 / (1 + r)15 Using trial-and-error, a financial calculator, or a computer, we find that: r = 9.9159% We can now calculate the before-tax cost of debt: Before-tax cost of debt = WA × rA + WB × rB = [($29,010,526 / $62,490,526) × .09] + [($33,480,000 / $62,490,526) × .099159] = .0949, or 9.49% b. After-tax cost of debt = Before-tax cost of debt × (1 - Tc) = 9.49% × (1 - .35) = 6.17%

The slope of the regression line that exhibits the past relationship between a stock's returns and the market's returns is the:

stock's beta.

For a company that pays no corporate taxes, its WACC will be equal to:

the expected return on it assets.

The slope of the security market line equals:

the market risk premium.

chapter 11: Figure 12.11 shows plots of monthly rates of return on three stocks versus the stock market index. The beta and standard deviation of each stock is given beside its plot. a. Which stock is safest for a diversified investor? b. Which stock is safest for an undiversified investor who puts all her funds in one of these stocks? c. Consider a portfolio with equal investments in each stock. What would this portfolio's beta have been? (Do not round intermediate calculations. Round your answer to 2 decimal places.) d. Consider a well-diversified portfolio made up of stocks with the same beta as Ford. What are the beta and standard deviation of this portfolio's return? The standard deviation of the market portfolio's return is 20%. (Do not round intermediate calculations. Round your beta answer to 2 decimal places. Enter your standard deviation answer as a percent rounded to 1 decimal place.) e. What is the expected rate of return on each stock? Use the capital asset pricing model with a market risk premium of 8%. The risk-free rate of interest is 4%. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

a. A diversified investor will find the lowest-beta stock safest. This is Newmont Mining, which has a beta of .59. b. Disney has the lowest total volatility; the standard deviation of its returns is 23.7%. c. β = (2.53 + 1.16 + .59) / 3 = 1.43 d. The portfolio will have the same beta as Ford (2.53). The total risk of the portfolio will be 2.53 times the total risk of the market portfolio because the effect of firm-specific risk will be diversified away. Therefore, the standard deviation of the portfolio is 2.53 × 20% = 50.6%. e. Using the CAPM, we compute the expected rate of return on each stock from the equation: r = rf + β(rm - rf) In this case: rf = 4% and (rm- rf) = 8% Ford r = 4% + (2.53 × 8%) = 24.24% Disney r = 4% + (1.16 × 8%) = 13.28% Newmont Mining r = 4% + (.59 × 8%) = 8.72%

The risk-free rate is 6% and the expected rate of return on the market portfolio is 13%. a. Calculate the required rate of return on a security with a beta of 1.25. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) b. If the security is expected to return 16%, is it overpriced or underpriced?

a. Required return = rf + β(rm − rf) = 6% + [1.25 × (13% − 6%)] = 14.75% b. The security is underpriced. Its expected return is greater than the required return given its level of risk.

We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, −.2. a. If the interest rate on Treasury bills is 5% and the expected return on the market portfolio is 15%, what is the expected return on the shares of the law firm according to the CAPM? (Enter your answer as a whole percent.) b. Suppose you invested 90% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

a. r = rf + β(rm − rf) = 5% + [(−.2) × (15% − 5%)] = 3% b. Portfolio beta = (.90 × βmarket) + (.10 × βlaw firm) = (.90 × 1.0) + [.10 × (−.2)] = .88

In 2013 Caterpillar Inc. had about 759 million shares outstanding. Their book value was $35 per share, and the market price was $94.50 per share. The company's balance sheet shows that the company had $32.5 billion of long-term debt, which was currently selling near par value. a. What was Caterpillar's book debt-to-value ratio? b. What was its market debt-to-value ratio? c. Which measure should you use to calculate the company's cost of capital? Book value or Market value

a. Book debt-to-value ratio = Debt / (Debt + Equity) = $32.5b / [$32.5b + (.759b × $35)] = .55 b. Market debt-to-value ratio = Debt / (Debt + Equity) = $32.5b / [$32.5b + (.759b × $94.50)] = .31 c. Market value is the proper measure, as it is determined by cash flows and forecasts, rather than accounting rules.

The risk-free rate is 6% and the expected rate of return on the market portfolio is 13%. a. Calculate the required rate of return on a security with a beta of 1.25. b. If the security is expected to return 16%, is it overpriced or underpriced?

a.Required return = rf + β(rm − rf) = 6% + [1.25 × (13% − 6%)] = 14.75% b. The security is underpriced. Its expected return is greater than the required return given its level of risk.

If the slope of the line measuring a stock's historic returns against the market's historic returns is positive, then the stock:

has a positive beta.

When the overall market experiences a decline of 8%, investors with portfolios of aggressive stocks will probably experience portfolio:

losses greater than 8%.

The company cost of capital:

measures what investors require from the company.